- - AGRICULTURE CORE CURRICULUM - - (CLF1000) Advanced Core Cluster: AGRICULTURAL BUSINESS MANAGEMENT (CLF1700) Unit Title: PURCHASING OPTIONS ______________________________________________________________________________ (CLF1701) Topic: Purchasing Options Time Year(s) 2 Hours 3 / 4 ______________________________________________________________________________ Topic Objectives: Upon completion of this lesson the student will be able to: Learning Outcome #: (O-1) - List the advantages and disadvantages of purchasing new versus old equipment. (O-2) - List the advantages and disadvantages of leasing. (O-3) - List factors to consider in purchasing seed, fertilizer, fuel, repairs, and other services. Special Materials and Equipment: References: Luening, R. A., Klemme, R. M., & Mortenson, W. P. (1991). THE FARM MANAGEMENT HANDBOOK (7th ed.). Danville, IL: Interstate Publishers. Resources: Deere & Company. (1987). FARM AND RANCH BUSINESS MANAGEMENT (2nd ed.). Available from: John Deere Technical Services, Department F, John Deere Rd., Moline, IL 61265. Evaluation: TOPIC PRESENTATION: Purchasing Options A. Careful consideration of purchasing options is an important part of an agricultural business manager's job. 1. The guiding principle in making any purchasing decision is to minimize the net cost of the item to be purchased. 2. The manager should examine all available options and consider the cost and quality of the items to be purchased when making purchasing decisions. 3. The terms and conditions of financing, delivery, and ongoing costs associated with the purchase should also be considered. 4. The tax implications of the purchase are also important factors in arriving at final decisions about purchases. B. General Considerations in Equipment Purchases 1. The machinery or equipment should fit the size and scope of the business. a. Bigger is not always better if the additional capacity of machinery will not be utilized. b. The size, complexity, and cost of any equipment purchased should be matched to the needs of the enterprise and the other equipment with which it will be used. 2. Productivity and efficiency should be the primary considerations in purchasing equipment. Comfort and style should be secondary considerations. 3. The purchase of one piece of machinery may have an impact on the utility of machinery presently in use. Also, the effects of a purchase of a major piece of equipment should be evaluated in terms of its effects on the future activities of the firm. 4. There are other options in addition to purchasing equipment. These include: a. Leasing or renting equipment b. Contracting for service with another farmer or business c. Exchanging machinery services with other producers d. Cooperative ownership of equipment or machinery C. Advantages and Disadvantages of Purchasing New and Used Equipment 1. Advantages of New Equipment a. New equipment is often more efficient, more productive, more reliable, safer, and more comfortable to operate than older equipment. b. The purchaser is protected from defects in the equipment by a warranty. c. Parts, operator and service manuals, and trained service personnel are readily available for new equipment. d. Financing of new equipment purchases can generally be obtained with a lower down payment than is required for used equipment. 2. Disadvantages of New Equipment a. The purchase price is generally much higher than for used equipment. Additionally, new equipment loses some value as soon as it leaves the dealer's lot. b. New equipment may not be cost effective if the equipment being replaced is still serviceable. c. The larger investment required for new equipment may strain the credit resources of the firm. 3. Advantages of Used Equipment a. The initial investment is lower. b. If the used equipment is reasonably reliable and performs at or near a level comparable to new equipment, it will be a more cost effective investment. 4. Disadvantages of Used Equipment a. Used equipment is generally less reliable than new equipment. b. The annual repair costs are generally higher for used equipment. c. Used equipment may have major defects of which the purchaser is unaware. d. Parts and qualified repair persons may be hard to find for used equipment. 5. Factors to Consider when Purchasing Used Equipment a. Is the service and repair history of the equipment well documented? b. Will the machinery be able to perform the job in a timely fashion? c. What is the trade-off between purchasing new or used equipment in terms of reliability, efficiency, productivity, and cost. d. Are repair parts and service available? D. Advantages and Disadvantages in Leasing and Purchasing Equipment 1. Advantages of Leasing a. The entire cost of leased equipment can be claimed as a business expense in the year it is leased. b. Leasing allows greater flexibility in farm and business operations. Equipment can be leased on a daily, weekly, monthly, or annual basis. c. Leased equipment is generally well-maintained and fairly new. 2. Disadvantages of Leasing a. No equity is built up with the money spent on leased equipment as it would be with purchased equipment. b. The long-term cost of leased equipment is generally higher. 3. Factors to Consider in Deciding Whether to Purchase or Lease Equipment a. A break-even analysis can easily be used to examine the cost of leasing versus purchasing. b. This analysis calculates the number of hours (or acres) of use at which the cost of renting will equal the cost of purchasing. It requires that the operator have accurate estimates of the annual fixed cost (i.e., principal and interest) of owning the equipment, and an accurate estimate of the variable cost of operation per hour (or acre). c. The variable costs should include the cost of fuel and repairs. d. The formula for determining the break-even point is: Total annual fixed costs Break-even hours = ------------------------------------------------ (lease cost per hour) - (variable cost per hour) e. For example, if the interest and and principal payments on a new combine are $10,000 per year, the lease cost is $50/hour and the variable cost is $25/hour, then the break-even hours would be 400: 10,000 -------------- = 400 50 - 25 This analysis shows that if the equipment is of equal productivity per hour, then leasing is the best alternative up to 400 hours. After that, owning would be less costly. E. Factors to Consider when Purchasing Materials, Supplies, Repairs, and Other Services 1. The total cost of the item, including delivery and storage costs a. Buying a large quantity of seed, feed, or fertilizer at low cost may not be a good decision if storage costs are high or spoilage likely. b. Time and expense in traveling farther to buy supplies at a lower price may cancel out the apparent savings. 2. Consider the quality of the product as well as the price. 3. Consider the terms of payment and any credit offered. 4. Consider the reputation of the firm for quality of service. 5. Consider whether a warranty or guarantee is offered by seller. __________________________________________________________ ACTIVITY: 1. To compare the cost of leasing and purchasing of equipment, use the purchase or lease of a pickup truck for the agriculture department as an example. Perform a break-even analysis based on miles of use. Determine what information is required to make the analysis and the need for accurate, up-to-date records. Discuss which other factors should be considered, i.e., insurance, license fees, delivery, and limitations on the use of a leased vehicle. __________________________________________________________ 10/30/91 EEZ/JA/sg #%&C