Renting Versus Purchasing Construction Equipment

For the contractor who is new in the construction business, the decision whether to rent or purchase equipment is usually quite easy to make because, lacking surplus cash and without a well-established credit rating, the only viable alternative is renting.

For the older, more mature construction business, the decision may be a great deal more difficult. This contractor, who is more likely to be in a position in which funds and credit sources are available for equipment investments, has to determine if such investments are justified. Buying construction equipment is justified only where the investment promises net benefits in comparison with the alternative of renting equipment and investing the cash elsewhere.

A contractor does not necessarily have to own any construction equipment in order to carry on business. In most parts of the country there are many companies in the construction equipment rental business offering competitive rental rates on a large selection of equipment. There can be distinct advantages to renting equipment, including:

1. The contractor does not have to maintain a large inventory of specialized plant and equipment where individual items are used infrequently.
2. The contractor has continuous access to the newest and most efficient items of equipment available.
3. There is little or no need for equipment warehouse and storage facilities.
4. There is a reduced need for the contractor to employ maintenance staff and operate facilities for their use.
5. Accounting for equipment costs can be simpler when equipment is rented.
6. There may be significant savings on company insurance premiums when a contractor is not maintaining a inventory of plant and equipment.

However, when the construction operations of a contractor generate a steady demand for the use of certain items of equipment or plant, there can be distinct financial benefits gained by owning equipment. There can also be a marketing advantage to the contractors who own their own equipment due to the perception that these contractors are more financially stable and committed than others who own no equipment. In fact, some owners require contractors who bid on their projects to list on the bid the company-owned equipment they propose to use in the work. This information is utilized in the owner’s assessment of the bidder.

Where a comparison of equipment ownership with the rental alternative strictly on the basis of cost is needed, the full cost per unit of time of owning an item of equipment has to be determined. To estimate the full ownership cost, the following aspects of equipment ownership have to be considered:

1. Depreciation expense
2. Maintenance and repair costs
3. Financing expenses
4. Taxes
5. Insurance costs
6. Storage costs
7. Fuel and lubrication costs

Depreciation

In everyday usage the term “depreciation” refers to the decline in market value of an asset. To accountants the term has a more narrow meaning having to do with allocating the acquisition cost of an item of plant over the useful life of that asset. The way this allocation of cost is calculated may or may not reflect the loss of market value; more often than not it does not. Also, the allocation of depreciation costs considered here is not related in any way to tax considerations. For tax purposes a completely different depreciation schedule may be adopted.

The process of allocating the cost of the item over its useful life is known as “amortization,” and there are several depreciation methods available to calculate amortization of an asset. Here we will consider three methods:
1. The straight-line method
2. The declining-balance method
3. The production or use method

Maintenance and Repair Costs

The costs of maintenance and repairs of plant and equipment comprise a factor that cannot be ignored when considering ownership costs. Equipment owners will agree that good maintenance, including periodic wear measurement, timely attention to recommended service, and daily cleaning when conditions warrant it, can extend the life of equipment and actually reduce the operating costs by minimizing the effects of adverse conditions. All items of plant and equipment used by a construction contractor will require maintenance and probably also some repairs during the course of their useful life. The contractor who owns equipment usually sets up facilities with workers qualified to perform the necessary maintenance operations on equipment. It is the cost of operating this setup that we have to consider and include in the total ownership charges applied to items of plant and equipment.

Construction operations can subject equipment to considerable wear and tear, but the amount of wear varies enormously between different items of equipment used and between different job conditions. The rates used in the following examples are based on the average costs of maintenance and repair, but since these costs can vary so much, the contractor formulating equipment operating prices should adjust the rates for maintenance and repairs according to the conditions the equipment is to work under. Again, as in many places in estimating, good records of previous costs in this area will much improve the quality of the estimator’s assessment of probable maintenance costs.

Maintenance and repair costs are calculated as a percentage of the annual depreciation costs for each item of equipment. When depreciation is calculated using the straight-line method, as in the examples 6 and 7 that follow, the result is a constant amount being charged yearly for depreciation and then a second constant amount is allowed for maintenance and repairs. Realistically, depreciation will be high in the early years of ownership, while actual maintenance and repair costs in these years should be low. The relative values of yearly depreciation and maintenance costs will gradually reverse until, in the later years, low depreciation will be accompanied by high maintenance and repair bills. Using a constant amount yearly for these two expenses, therefore, would seem reasonable as the variance of one factor is offset by the countervariance of the other factor.

Financing Expenses

Whether the owner of construction equipment purchases the equipment using cash or whether the purchase is financed by a loan from a lending institution, there is going to be an interest expense involved. The interest expense is the cost of using capital; where cash is used, it is the amount that would have been earned had the money been invested elsewhere, that is, the forgone interest revenue. Where the purchase is financed by a loan, the interest expense is the interest charged on the loan. In both cases the interest expense can be calculated by applying an interest rate to the owner’s average annual investment in the unit. The average annual investment is approximately midway between the total initial cost of the unit and its salvage value.
Thus:
average annual Investment = (Total Initial Cost + Salvage Value)/2

The interest rate used to calculate the financing expense will vary from time to time, from place to place and also from one company to another depending mostly on its credit rating and how good a deal it can get from the lending institution. In the examples that follow, we will use a rate of 6%.

Taxes, Insurance, and Storage Costs

Just as with investment expenses, significant variations can be expected in the cost of the annual taxes, insurance premiums, and storage costs together with fees for licenses required and other fees expended on an item of equipment. Where these expenses are known, they should be added into the calculation of the annual ownership costs of the equipment. In the case where information on these costs is not available, they may be calculated as a percentage of the average annual investment cost of the piece of equipment. The interest expense rate and the rate for taxes, insurance, and storage costs are often combined to give a total equipment overhead rate. Below we will use an equipment overhead rate of 11%, which comprises 6% for the investment rate and 5% to cover taxes, insurance, and storage costs.

Fuel and Lubrication Costs

Fuel consumption and the consumption of lubrication oil can be closely monitored in the field. Data from these field observations will enable the estimator to quite accurately predict future rates of consumption under similar working conditions. However, if there is no access to this information, consumption can be predicted where the size and type of engine are known and the likely engine operating factor is estimated. This operating factor is an assessment of the load under which the engine is operating. An engine continually producing full-rated horsepower is operating at a factor of 100%. Construction equipment never operates at this level for extended periods, so the operating factor used in calculating overall fuel consumption is always a value less than 100%. The operating factor is yet another variable with a wide range of possible values responding to the many different conditions that might be encountered when the equipment under consideration is used. In the examples that follow, the specific operating factors used can be no more than averages reflecting normal work conditions. Again, there is no good substitute for hard data carefully obtained in the observation of actual operations in progress.

When operating under normal conditions, namely, at a barometric pressure of 29.9 in. of mercury and at a temperature of 60ºF, a gasoline engine will consume approximately 0.06 gallons of fuel for each horsepower-hour developed. A diesel engine is slightly more efficient at 0.04 gal. of fuel for each horsepower-hour developed.

Equipment Operator Costs

Whether a contractor decides to rent or own the equipment used on its projects, the cost of operating the equipment has to be considered. In some situations rentals may be available that include an operating engineer as part of the rental agreement. This variety of rental agreement is sometimes available for excavation equipment, and it can be a preferred alternative when the rental company offers a high-caliber equipment operator who is familiar with the particular excavation unit and is capable of high productivity.

More often than not, however, equipment is rented without an operator. So, just as in the case in which the contractor is using company-owned equipment, the labor costs for operating the equipment have to be calculated and added to the estimate. The usual way to price these costs is to apply an operating engineer’s hourly wage alongside the equipment hourly rate and then use the expected productivity of the equipment to determine a price per measured unit for labor and a price per measured unit for equipment. Example 5 illustrates this method of pricing equipment and operator’s costs. Note that the unit prices for labor and for equipment should always be considered separately as the labor prices have to be included in the total labor content of the estimate so that “add-ons” can be applied to this amount at the close of the bid.

Example:

Where the hourly cost of an excavator is $172.00, the wage of an operator for this equipment is $40.00 per hour, and the expected productivity of the excavator is 50 cu. yd. per hour, the unit prices for labor and equipment would be calculated thus:
Labor
$40.00/50 cu. yd.
= $ 0.80 per cu. yd.

Equipment

$172.00/50 cu. yd.

= $ 3.44 per cu. yd.
These unit prices can now be applied to the total quantity of excavation that this equipment is expected to perform in accordance with the takeoff.

Company Overhead Costs

Where the equipment ownership costs calculated in accordance with this chapter are to be used as a basis of rental rates charged by the contractor to others for the use of the contractor’s equipment, the full rental rates should include an amount for company overhead costs and amount for profit. Company overhead costs are basically the fixed costs associated with running a business. They may include the cost of maintaining a furnished office, office equipment, and personnel together with all the other costs of business operation. Since the rental rate quoted by a contractor to another party for the use of the contractor’s equipment is, in a sense, a kind of bid, the same considerations should be applied to the markup on the rental rate as are applied to markup on any of a contractor’s bids.