Does buying pre-owned machines save investment/costs?

When setting up a new factory like I am doing now, one is often confronted with a dilemma, should I buy new machines or buy pre-owned (second hand, used) machines at a lesser cost?

Used machines are ready for sale by those who have either shut down their unit or expanding/modernizing their unit. Many times they have not been used for long time, in good working condition and available at half the original price. Such offers look very attractive and is tempting for many cash strapped entrepreneurs. My dad and I visited a couple of such Oil Mills in Kochi and Kangeyam and we were pretty much convinced about buying them out because of the following reasons

1. Quick Project completion - To setup a factory with new machineries requires the lengthy procurement process i.e. Seeking quotations, selection of vendor, negotiations, payment, time for making the machine, transportation and installation. Also buying of accessories for the integration of the machineries to form a production system. For used machines, time till installation is significantly reduced because all the machines are already available at one place.

2. Investment size reduces to 50% of the budgeted investment. Extra money remaining can be used as working capital.

Within a week of this I visited Chennai for a Packaging exhibition and stayed at Raghuram's place there. While discussing my idea, he advised caution. He told me to focus on setting up a state of the art factory with latest machineries. Also he pointed towards the depreciation I can claim. His ideas then didn't affect my opinion. But later while travelling back, I started thinking deeply about what he told. And I came up with the following reasons to suggest that it is not that attractive despite the apparent attractiveness.

Investment - Assume used machineries cost 50% of that of new one.

1. Bank Loan - Banks don't easily give loans to buy used machines, they are comfortable funding machines where the supplier is a manufacturer and has quotations to back the price. Required margin money on machineries is 25% of its value or the bank funds 75% of the machine. While for used machine the buyer has to have 100% of the value or 50% of that of new one. So, initial cash outlay for new machines is 25% vs used machines is 50%.

2. Subsidies - Taking the case of my project of setting up a coconut oil mill. Coconut Board gives 25% subsidy on total investment, Directorate of Industries and Commerce (DIC) gives 15% subsidy, there are a few other incentives also. In short about 40% of total investment is subsidized by government. To get subsidy the industrialist must have gone for bank loan for funding. Both banks and government fund only for new machines. So, it is 50% for used machines vs 60% for new machines scenario. Used machine's advantage is only 10% of the total value.

3. Depreciation - Claiming depreciation on assets helps in showing the investment as an expenditure, this helps in saving tax to be paid on profits. Assuming tax rate of 30%, for new machines 30% of the cost of machines can be saved in taxes while for old machines 30% of 50% value i.e. 15% is the tax saved. So, new machines help in saving 15% more tax than old machines.

After considering Subsidies and Depreciation alone, new machines have 5% advantage (-10% subsidies + 15% depreciation) over used machines! This much is sufficient to answer the question raised in the title of the post. Wait, it is not over there are lot more things to talk about in favour of new machines.

Features - New machines have more and better features compared to the old machine. More importantly, the buyer can get those features that suites his requirements.

Efficiency - New machines would be more optimised than old ones and they will perform better, faster and with lesser power and consumables.

Maintenance - New machines are less susceptible to breakdowns as compared to old machines. Some of the problems encountered with older models would have been sorted out with later versions. That means lesser downtime, better productivity, lesser cost in buying spares and service.

Warranty - New machines come with one year warranty, few free services, installation and training.

Life - New machines have longer life and gives more time to realize value out of the machine.

New machine will give peace of mind (most precious commodity) to the businessman and allow him to concentrate on his business than on the machine. This enables him to keep him ahead of the competitors and better serve the customers.

Similarly, throughout my professional course (BE and MBA), I have always bought new text books and have never been a fan of photo copies or used books.