Farm machinery costs can be divided into two categories: annual ownership costs, which occur regardless of machine use, and operating costs, which vary directly with the amount of machine use.
The following recommendations, formulas, and charts were provided by Iowa State University.
NOTE: A sample tractor will be used throughout to illustrate the calculations: a 10-year-old, 105-horsepower (hp) diesel tractor with a list price of $80,000, discounted to a $75,000 purchase price. The tractor is used about 400 hours per year.
How to Calculate Ownership Costs
The formula for total ownership costs (also called fixed costs) is simply adding two figures together: the capital recovery and a combo number of taxes, insurance, and housing (TIH). But those two numbers need their own calculation.
Capital Recovery. The first steps in arriving at this figure is finding your tractor’s salvage value, then depreciation cost.
Salvage value is the amount you could expect to receive as a trade-in allowance, or an estimate of the used market value if you expect to sell the machine.
Again, the formula is simple: Multiply the purchase price with the “remaining value factor,” a percentage that can be found in a chart Iowa State created. A small portion of this chart, shown below, includes our 10-year-old sample tractor’s remaining value factor is 37%.
Using our sample tractor again, here’s how you calculate the salvage value: $75,000 (purchase price) x 37% (remaining value factor) = $ 27,750
Now you’ll use that number to calculate the cost of your tractor’s depreciation. Here’s the formula:
Total Depreciation = Purchase Price – Salvage Value
Using this formula, the sample tractor’s total depreciation is $47,250 (the sum of $75,000 minus $27,750).
Remaining Value Factor
|Age||80-149 hp Tractor with 400 Annual Hours|
Another figure needs to be calculated, the “real” interest rate. Iowa State suggests deducting inflation from the interest rate you were given when purchasing the tractor. For the sake of our examples, let’s say the lender’s interest rate was 7%, and inflation is at 2%. So, the real interest rate is 5%.
One last number needed before calculating the capital recovery is the capital recover factor. Iowa State has a chart that will give you this number based on the age of the tractor and the real interest rate. For our 10-year-old sample tractor with a 5% real interest rate, that number is 0.130.
Now we can calculate the figure for capital recovery.
Capital recovery = (total depreciation x capital recovery factor) + (salvage value x interest rate)
Using our sample, that will look like this: ($47,250 x .130) + ($27,750 x .05) or $6,142.50 + $1,387.50
So the tractor’s capital recovery is $7,530 per year
Taxes, insurance, and housing (TIH). These three costs are usually much smaller than depreciation and interest, but they need to be considered.
Despite its long title, TIH is much easier to calculate than capital recovery. Iowa State recommends you lump together all taxes, insurance, and housing (such as a maintenance shed) costs together by multiplying the tractor’s average value by 1% (assuming property taxes don’t apply).
The average value is arrived at by dividing the sum of the purchase price and the salvage value in half. That makes the formula look like this:
TIH = 0.01 x (purchase price + salvage value) / 2
For our tractor example, these three costs would be:
TIH = 0.01 x ($75,000 + $27,750) / 2
= $513.75 per year
Total Ownership Cost
Bringing this all together, let’s go back to the original formula for total ownership costs:
Total Ownership Cost (also called fixed costs) = Capital Recovery + TIH
Or $7,530 + $513.75 = $8,043.75 per year
Now we can translate that figure into costs per hour. If the tractor is used 400 hours per year, the total ownership per hour is $8,043.75 / 400 hours, equaling $20.11 per hour.
To calculate operational costs, check out part 2 of How Much Will That Tractor Cost?