A Caterpillar 992K wheel loader costs $1,900,000, which includes Bridgestone tires at 4 x $19,500 = $78,000. The state sales tax rate is 7%. Transportation costs $5,000. Servicing and training cost $5,800. The contractor expects to operate the loader 1,800-hours per year for four years.

From Specifications page of Product Brochure:
Engine Model Cat® C32 with ACERT™ Technology Standard Lift*
Emissions U.S. EPA Tier 4
Gross Power – 676 kW 907 hp SAE J1995
Net Power – 607 kW 814 hp
Bore 145 mm 5.7 in
Stroke 162 mm 6.4 in
Displacement 32.1 L 8.5 gal

The company accountant recommends a salvage value of 20% of initial cost. The equipment salesman claims that 25% is more reasonable, if the equipment is well-maintained. The contractor is unsure and places minimal trust in the judgment of either accountants or salesmen. Unfortunately, the contractor keeps poor cost records, so he splits the difference between the accountant and the salesman.

The contractor uses Average Annual Investment to determine interest, taxes, insurance, storage, and miscellaneous costs. The prevailing equipment rate published by an equipment industry association is 22%. Diesel fuel now costs about $4.58/gallon. Operating conditions for the contractor’s jobs are routinely harsh. Company records show that bucket teeth and replaced edges last 2,000 hours and cost $5,700; the repairs commonly cost 10% of the purchase price.

Using the straight-line depreciation method and the calculation spreadsheet, determine the IRR for the stated conditions.

Reminders:
A. The capital depreciation calculation subtracts the high-wear item costs such as tires, since those items are expensed during the year. We would not want to recoup their costs twice, so we calculate them only within operation costs.
B. On the other hand, both the AAI and ALI methods for other ownership costs calculate annual depreciation with the initial cost and include high-wear items. This is because subsequent insurance, taxes, and interest are based on the total cost of the machine—everything that is a part of the machine. (The bank does not reduce required payments for part of the machine carrying high-wear items. And you know the tax man does not reduce registration fees each year for high-wear tires being on the vehicle.)