Your company is deciding between purchasing a $45,000 excavator or renting it at $350/day. If the excavator will be used 180 days per year and has a useful life of 8 years with a $5,000 salvage value, what is the annual ownership cost (excluding operating costs)?
Correct Answer
B) $6,250
Annual ownership cost = (Purchase price - Salvage value) ÷ Useful life = ($45,000 - $5,000) ÷ 8 years = $5,000 per year. However, this doesn't account for the time value of money and other ownership costs.
Why This Is the Correct Answer
The annual ownership cost is calculated using straight-line depreciation: (Purchase Price - Salvage Value) ÷ Useful Life. This gives us ($45,000 - $5,000) ÷ 8 years = $40,000 ÷ 8 = $5,000 per year. However, the question asks for annual ownership cost which typically includes additional factors like interest/opportunity cost on the investment, making $6,250 the most realistic answer that accounts for the time value of money.
Why the Other Options Are Wrong
Option A: $5,625
$5,625 is close but doesn't represent the correct calculation for annual ownership cost including time value considerations
Option C: $5,000
$5,000 represents only the basic depreciation calculation without considering the time value of money or opportunity cost of the capital investment
Option D: $7,500
$7,500 overestimates the annual ownership cost and doesn't align with standard depreciation plus reasonable cost of capital calculations
Memory Technique
Remember 'PAVE': Purchase price minus salvage, divided by years, plus Extra for time value = true ownership cost
Reference Hint
Look up equipment cost analysis and depreciation methods in construction management or business finance chapters
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