Steve Hammer started his contracting business, Hammer Contractors (HC), six years ago and now owns three machines: a bulldozer, an excavator, and a front-end loader. His business is primarily excavating, landscaping, and moving earth. His sole proprietorship has a year-end of December 31. He employs three full-time people, and his wife, Judy, does all the bookkeeping and office work on a part-time basis. HC has been quite successful. According to Judy’s figures, the business earned $86,000 before depreciation in 2010 after deducting $26,000 of “salary” paid to Steve.
Steve and Judy have no training in accounting or financial matters and have approached you, early in 2011, for assistance in deciding whether a new grader should be purchased. Some of HC’s jobs are obtained by sealed tender but others are from repeat customers who like Steve’s reliability and ability to offer full service. Steve wants to extend this service by purchasing a grader in time for the spring construction season. He has made the following estimates about the new grader:
Major repair expenses were predicted by his to be $6,000 in Year 4, $20,000 in Year 6, and $28,000 in Year 9. Insurance on the machine is expected to amount to $2,400 a year.
Steve estimates that on some jobs he can charge $60 per hour for use of this machine. However, other jobs are very competitive and he would like to know how low he could drop his price on the grader before he starts losing money.
Steve estimates about 2,000 hours of use from the grader yearly.
Major repair expenses were predicted by his to be $6,000 in Year 4, $20,000 in Year 6, and $28,000 in Year 9. Insurance on the machine is expected to amount to $2,400 a year. Steve estimates that on some jobs he can charge $60 per hour for use of this machine. However, other jobs are very competitive and he would like to know how low he could drop his price on the grader before he starts losing money. Steve estimates about 2,000 hours of use from the grader yearly.
Required
Draft a report to Steve Hammer that analyzes the issue and provides your recommendation. Assume a required rate of return of 10 percent, an income tax rate of 35 percent, and a capital cost allowance of 25 percent
