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PLANTING EQUIPMENT

CHAPTER 13
ECONOMICS OF FARM MACHINERY
ARSENIO N. RESURRECION and MARVIN C. PETINGCO

Economics play a vital role in agricultural machinery management. Selection of


the size and capacity of a machine for a particular job requires careful evaluation of all
cost items. Oversized machines require higher investment and may be too large for
economic operation with the rest of the machines in the farm (Hunt, 1983). Undersized
machines may give a lower investment but the increased labor cost may offset the
savings.

The machine that would give the lower investment and operating costs is
recommended. The final decision is influenced by the following:

1. suitability of the machine to the crop, to the field, and to weather


conditions.

2. timeliness of field operation which is governed by the capacity of the


machine.

3. availability of capital.

4. cost and availability of labor and fuel.

BENEFITS AND COSTS OF AGRICULTURAL MACHINERY OPERATION

Benefits include income from custom work, time and cost savings, value of
yields, and salvage value. On the other hand, costs include charges for the use of the
machine, i.e. power, fuel and oil utilized, and labor used. Costs can be grouped into two
categories: fixed costs and variable costs.

Fixed costs are expenses incurred regardless of whether the machine is operated
or not. These include: (a) depreciation; (b) interest on investment; (c) shelter; (d) taxes
and insurance; and (e) repair & maintenance.

1. Depreciation (D ) is the reduction in the value of the machine as a result


of use (wear and tear) and obsolescence (availability of newer and better
model). Most common method of computing depreciation is the straight-
line method.

Initial cost - Salvage value IC - SV


D=  eqn. 1
Useful life L
where:
SV = salvage value of the machine at the end of useful life usually
estimated at zero to 10 percent of initial cost.
L = useful life based on experience and similar machines
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2. Interest on Investment (IOI) is the charge for the use of the money
invested on the machine regardless of whether the money was borrowed
or not. It is given by the equation below.

(IC  SV)
IOI = Xr eqn. 2
2
Where r = interest rate
= bank interest rate on agricultural loans

3. Shelter is provided to protect the machine from robbers and adverse


weather conditions, for ease of making repairs, and for better appearance
of the farm. Included in the computation of depreciation, interest on
investment, insurance, and repair and maintenance.

4. Insurance is the cost of protection of the machine and shelter against


calamities and theft.

5. Repair and maintenance costs are fixed allowances provided for the repair
of machine and shelter. Usually estimated at 10 percent of initial cost.

6. Taxes are sometimes collected in some places when machine is required


to be registered with the local government.

Variable costs are expenses incurred as a result of machine operation. These


include power costs, labor, and other inputs.

1. Power costs (electricity, fuel and oil) are usually the largest item of expense
in operating powered machines.

2. Labor is required to operate and maintain machines. Wage rates prevailing


locally should be used.

3. Other inputs include other items of cost needed for the operation of the
machine.

PROJECT APPRAISAL

Project appraisal provides a comprehensive review of all aspects of the project. It


includes economic and financial analysis wherein analysis of economic soundness of the
project, quantification and valuation of costs and benefits and ensuring financial viability
are done (www.usea.org).

METHODS OF PROJECT EVALUATION


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The methods more often used for evaluating a project are (1) Simple rate of
return (SRR), (2) Payback Period (PBP), (3) Break-Even Point (BEP), (4) Benefit Cost
Ratio (BCR), (5) Net present Value (NVP) or Net Present Worth (NPW) and (6) Internal
Rate of Return (IRR) (Sarma, 2010).

The SRR, PBP and BEP are the undiscounted measures while BCR, NVP and
IRR are the discounted measures of project worth of investment. Undiscounted
measures of project appraisal do not take into consideration the change in the value of
money over time while discounted measures take into account time value of money
through the process of discounting (Resurreccion, 2004).

UNDISCOUNTED MEASURES OF PROJECT WORTH

a. Simple Rate of Return

The SRR is a commonly used criterion of project evaluation. It basically expresses


the average net profits (Net Cash Flows) generated each year by an investment as a
percentage of investment over the investment’s expected life. It can be determined
using the equation:

SRR = Y/I eqn. 3


Where:
Y = the average annual net profit (after allowing depreciation) from the
investment
I = the initial investment

The calculated SRR should be compared with the investor’s Required Rate of Return
(RRR) to judge the profitability of the investment. The investment will be accepted if
SRR > RRR, otherwise it will be rejected. When the SRR of all the investment
opportunities is greater than the RRR of the investor, then the investment yielding the
highest SRR should be selected.

b. Payback period (PBP) is length of time it takes to recover the invested capital or
until the net benefits equal the investment cost. Here, depreciation is not included in
the computation of cost to avoid double accounting since the initial capital is included
in the computation.

Initial investment
PBP = eqn. 4
Avearage annual net benefits

where:

 (Total Benefits - Total Costs)


1
Ave. annual net benefits =
n
n = no. of years of benefits
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Individual investments are ranked according to their relative pay back period with the
shortest being the most favored. The acceptability of the investment is determined by
comparison with the investor’s required pay back period (RPP). Accept the investment
when the PBP<RPP, otherwise reject the investment. Although it is simple and easy to
use, the PBP method has two major weaknesses as a measure of investment worth: (1)
this method fails to consider earnings after the pay back period is reached, and (2) it
fails to consider the difference in timing of cash flows.

c. Break-even point (BEP) is level of operation where it neither produces a profit


nor incurs a loss.

AFC + VC (X) = B (X) eqn. 5

Where:

AFC = annual fixed cost


VC = unit variable cost
B = Unit benefit
X = no. of units for break-even point

Select an investment with BEP that has a lower break-even point among the
alternatives. An investment should be operated above the BEP to be economical.

DISCOUNTED MEASURES OF PROJECT WORTH

Discounting is a process of translating future values in present worth by applying


a set of discount factors.

PW = DF x V eqn. 6

Where:

PW = present worth
1
DF = Discount factor =
(1  r) n
r = prevailing bank interest rate
n = no. of years
V = worth of money in the future

Example: Find the present worth of P1,000 to be received two years from
now at the prevailing bank rate of 21%.

Solution:
1
PW = x P1,000 = 0.683 x P1,000 = P683
(1  0.21) 2
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a. Benefit-cost ratio (BCR) is the ratio of present worth of benefit stream to present
worth of cost stream and is given by the equation below:
n
Bi
 (1  r)
i 0
i
PWB
BCR = = eqn. 7
n
Ci PWC

i  0 (1  r)
i

Where:

Bi = benefits in period i where i runs from zero to n


Ci = Costs in period i where i runs from zero to n
PWB = present worth benefits
PWC = present worth costs

.
The investment is said to be profitable when the BCR is one or greater than 1.
Depreciation and interest on investment are not included in the costs to prevent
double accounting. Depreciation is taken cared of by the inclusion of the
investment cost while interest on investment is taken cared of by the discount
factor.

b. Net Present Value is computed by finding the difference between the present worth of
benefit stream less the present worth of cost stream. It is simply the present worth of the
cash flow stream since it is a discounted cash flow measure of project worth along with
internal rate of return.

n
Bi  C i
NPV = PWB – PWC =  (1  r)
i 0
i
eqn. 8

c. Internal rate of return (IRR) is that discount rate which just makes the net present
value (NVP) of the cash flow equal zero. It is considered to be the most useful measure
of project worth. It represents the average earning power of the money used in the
project over the project life. It is also sometimes called yield of the investment.

It is the maximum interest that a project can pay for the use of resources if
the project is to recover its investment and operating cost and still break-even. At
this point, the BCR is equal to one. This is usually done by trial and error and by
interpolation and using following equations:
 NPVLIR 
IRR = LIR  HIR - LIR  x
abs /NPVHIR  NPVLIR / 
eqn. 9

n
Bi  C i
NPV = net present value ==  (1  r)
i 0
i
= PWB - PWC

where:
LIR = lower interest rate
HIR = higher interest rate
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(IC  SV)
IOI = Xr eqn. 2
2
Where r = interest rate
= bank interest rate on agricultural loans

SUMMARY ILLUSTRATION

Los Los Baños Machinery Pool, Inc. needs to provide land preparation and
threshing services for rice production. The following machines/equipments with their
specifications are selected.

Table 1. Machines/equipment specifications


2W Tractor
Power (hp) Gasoline 7
Diesel 6 to 9
Capacity (ha/day)(8 hr 1st pass 1
operation) 2nd pass 2

Walking Type Transplanter


Power (hp) Gasoline 7
Diesel 6 to 9
Capacity (ha/day) 1

Knapsack Sprayer
Power Manual
Capacity (ha/day) 1

1-M Rice Reaper


Power (hp) Gasoline 7
Diesel 8 to 10
Capacity (ha/day) 2

Axial Flow Thresher


Power (hp) Gasoline 8 to 10
Diesel 10
Capacity (kg/h) (rough rice) 1000

Determine the PBP, BEP, BCR and IRR of the investment. Based on the result
of each measure of project worth, decide whether to accept or reject the investment.

Solution:
The basic assumptions (Table 2) and cost and return analysis (Table 3) are
tabulated below.
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Table 2. Basic Assumptions


Items Value
Service Area (ha) 30
Life of Equipment (years) 5
Fuel Consumption (L/h) 2
Fuel Cost (P/L) (Diesel) 30
Oil Consumption (L/h) 0.1
Oil Cost (P/L) 150
Custom Fee Charges (P/ha)
Land Prep (2 passes) 3000
Transplanting 1500
Spraying 1500
Harvesting 1500
Threshing (10% of Output) 7800
Wages (P/day)
Land Prep (per operator) 350
Transplanting (per operator) 350
Spraying (per operator) 350
Harvesting (per operator) 350
Threshing (30% of share of custom fee) 2340
Average Yield (tons/ha) 6
Croppings per year 2
Price of Palay (P/kg) 13
Price of Palay (P/ton) 13000

Equipment Cost
2W Tractor 20,000
Walking Type Transplanter 15,000
Knapsack Sprayer 2500
1-M Rice Reaper 50000
Axial Flow Thresher 30,000
Engine (10hp Diesel) 60,000
Shed Area (m2) 40
Price of Shed (P/m2) 4000
Cost of Shed (P) 160000
Initial cost 337,500
Salvage Value (10% of IC) 0.1
Interest Rate (%/100) 0.12
Repair and Maintenance (%/100) 0.1
Working Day (hrs/day) 8
# of Operators 2
Ammortization (3 equal payments for 3 yrs) 112500
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Table 3. Cost and return analysis


Item Value
Fixed Costs P/ha P/year (60 ha)
Depreciation 1013 60750
Interest on Investment 371 22275
Repair and maintenance 563 33750
Total Fixed Cost 1946 116775

Variable Costs
Fuel
Land Preparation 720 43200
Transplanting 480 28800
Harvesting 240 14400
Threshing 360 21600
Total 1800 108000
Oil
Land Preparation 180 10800
Transplanting 120 7200
Harvesting 60 3600
Threshing 90 5400
Total 450 27000
Wages
Land Preparation 1,050 63000
Transplanting 700 42000
Spraying 700 42000
Harvesting 350 21000
Threshing 2340 140400
Total 5,140 308400
Total 7,390 443400

Returns
Land Preparation 3000 180000
Transplanting 1500 90000
Spraying 1500 90000
Harvesting 1500 90000
Threshing 7800 468000
Total 15300 918000
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Table 4. Payback period calculation

Year IC FC TVC TC Gross Benefits Net Benefits Years


1 337,500 56025 443400 836,925 918000 81,075
2 56025 443400 499425 918000 418,575
3 56025 443400 499425 918000 418,575
4 56025 443400 499425 918000 418,575
5 56025 443400 499425 918000 418,575

Salvage Value at end of 5th Year 33750


Total net benefits 1,789,125
Average Annual Net Benefits 357825
Payback Period 0.9

* Depreciation cost was deleted from fixed cost to prevent double accounting since initial capital had been included in the computation
already. Or remove IC during the 1st year and include depreciation each year for 5 years.

:. Accept project because PBP is less which is much lower than the life of equipment (5 years), the required payback period.

Table 5. Break-even point computation

Item Value
Fixed cost (p/yr) 116775
Variable cost (P/ha) 7,390
Benefits (P/ha) 15300
Break-Even Point (BEP, ha/yr) 14.8

:. Accept project because BEP is 14.8 ha/yr which is lower than the service area of 60 ha/yr
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Table 6. Benefit-cost ratio calculation


Year
Item Total
0 1 2 3 4 5
Cash Inflow (benefits) 0 918000 918000 918000 918000 918000

Cash Outflow (costs)


Equip & Shed (IC) 337,500 0 0 0 0 0
Operating Cost 0 477150 477150 477150 477150 477150
Ammortization 0 0 0 0 0 0
Total 337,500 477,150 477,150 477,150 477,150 477,150

Net Cash Flow -337,500 440,850 440,850 440,850 440,850 440,850

Discount Factor 1.000 0.893 0.797 0.712 0.636 0.567

Present Worth Benefits 0 819643 731824 653414 583406 520898 3309185

Present Worth Costs 337500 426027 380381 339626 303237 270748 2057519

Benefit-Cost Ratio (BCR) 1.61


*Depreciation and Interest on Investment are not included in the Operating Cost to prevent double accounting. Depreciation is taken
cared of by the inclusion of Investment Cost (equipment and shed). Interest on Investment is taken cared of by the Discount Factor.

:. With BCR > 1, accept project.


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Table 7. Internal Rate of Return computation


Year
Item Total
0 1 2 3 4 5
Cash Inflow (benefits) 0 918000 918000 918000 918000 918000

Cash Outflow (costs)


Equip & Shed (IC) 337,500 0 0 0 0 0
Operating Cost 0 477150 477150 477150 477150 477150
Ammortization 0 0 0 0 0 0
Total 337,500 477,150 477,150 477,150 477,150 477,150

LIR 1.28 HIR 1.29


First Trial
Discount Factor (128%) 1.000 0.439 0.192 0.084 0.037 0.016

Present Worth Benefits 0 402632 176593 77453 33971 14899 705547

Present Worth Costs 337500 209276 91788 40258 17657 7744 704223

Net Present Value -337500 193355 84805 37195 16314 7155 1324
Second Trial
Discount Factor (129%) 1.000 0.437 0.191 0.083 0.036 0.016

Present Worth Benefits 0 400873 175054 76443 33381 14577 700328

Present Worth Costs 337500 208362 90988 39733 17351 7577 701510

Net Present Value -337500 192511 84066 36710 16031 7000 -1182
Internal Rate of Return (%) 128.52828
*Depreciation and Interest on Investment are not included in the Operating Cost to prevent double accounting. Depreciation is taken
cared of by the inclusion of Investment Cost (equipment and shed). Interest on Investment is taken cared of by the Discount Factor.
:. Accept project if prevailing bank interest rate is lower than 128 %.
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A. Fixed Costs:
IC - SV 337,500 x 0.9
1. D= = = P 60,750 SV = 10% of IC
L 5
IC  SV 337,500x 1.1
2. IOI = xr = x 0.12 = P 22,275
2 2
a. R & M = 337,500 x 0.10 = P33,750

B. Variable Costs:
1. Fuel
Land prep.:
1st pass: 8 hrs/day x 1day/ha x P30/ liter x 2 liters/hr = P480/ha
2nd pass: 8 hrs/day x 1day/2ha x P30/ liter x 2 liters/hr =P240/ha
P720/ha
Transplanting:
8 hrs/day x 1day/ha x P30/ liter x 2 liters/hr = P480/ha

Harvesting:
8 hrs/day x 1day/2ha x P30/ liter x 2 liters/hr = P240/ha

Threshing:
6 tons/ha x 1000kg/ton x 1hr/1000kg x P30/ liter x 2liters/hr
=P360/ha

2. Oil
Land prep.:
1st pass: 8 hrs/day x 1day/ha x P150/ liter x 0.1 liters/hr = P120/ha
2nd pass:8 hrs/day x 1day/2ha x P150/ liter x 0.1 liters/hr =P 60/ha
P180/ha
Transplanting:
8 hrs/day x 1day/ha x P150/ liter x 0.1 liters/hr = P120/ha

Harvesting:
8 hrs/day x 1day/2ha x P150/ liter x 0.1 liters/hr = P 60/ha

Threshing:
6 tons/ha x 1000kg/ton x 1hr/1000kg x P150/ liter x 0.1liters/hr
= P 90/ha
4. Wages:
Land prep.:
1st pass: P350/ day x 1day/ha x 2 operators = P 700/ha
2nd pass: P350/ day x 1day/2ha x 2 operators = P 350/ha
P1,050/ha
Transplanting:
P350day x 1day/ha x 2 operators =P 700/ha
Harvesting:
P350day x 1day/2ha x 2 operators =P 350/ha
Threshing:
P7,800/ha X 30% = P2,340/ha
(30% of custom fee charge for threshing per ha)
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C. Returns
Land preparation: P3,000/ ha
Transplanting: P1,500/ ha
Harvesting: P1,500/ ha
Threshing: P7,800/ha (6 tons/ha x P13,000/ton x 10%)

REFERENCES
Hunt, D. 1983. Farm Power and Machinery Management: Laboratory Manual and
Workbook. Iowa state University Press.

Sarma, A. K. 2010. Methods/Criteria of Project Evaluation or Measures of project Worth


of Investment. Agril. Economics,FA, AAU, Jorhat.

Resurreccion, A. N and R. C Amongo. 2010. Lecture Notes in AENG 62. Agricultural


Machinery Division, Institute of agricultural Engineering, CEAT, UPLB.

www.usea.org/.../World%20Bank%20Project%20Appraisal.pdf
www.assamagribusiness.nic.in/agriclinics/Methods%20