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Capitalized Cost Analysis Guide

Capitalized cost is the sum of first cost, present worth of perpetual operation and maintenance expenses, and present worth of perpetual replacement expenses. It is calculated for assets with perpetual lives by discounting future cash flows. The example shows calculating the capitalized cost of a research laboratory over 20 years and a charitable endowment in perpetuity, discounting costs and salvage values to get present worth values using interest rates.

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874 views4 pages

Capitalized Cost Analysis Guide

Capitalized cost is the sum of first cost, present worth of perpetual operation and maintenance expenses, and present worth of perpetual replacement expenses. It is calculated for assets with perpetual lives by discounting future cash flows. The example shows calculating the capitalized cost of a research laboratory over 20 years and a charitable endowment in perpetuity, discounting costs and salvage values to get present worth values using interest rates.

Uploaded by

Dhdu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CAPITALIZED COST

Definition:

Capitalized Cost is the sum of the first cost present worth for the perpetual operation and maintenance
expenses and the present worth for perpetual expenses.

Assumptions:

1. The business has perpetual life


2. The business is bigtime

S = 1T S = 1T

0 1 2 3 4 5 L = 300 L=∞

FC = 200B 0/M 0/M 0/M 0/M 0/M 0/M 0/M

P = 300B i = 10%

X = 400B

FC = First Cost

= the cost in putting up the business

= Building, Lupa, Taxes, Insurance

P = Present worth or perpetual operation and maintenance expenses

x/s = the present worth for perpetual replacement expenses

CC = FC + P+ X

CC = 200B + 300B +400B

CC = 900
S

Ordinary Annuity
0 1 2 3 4 5 L-1

i i i i i i i i

xi xi xi xi xi xi xi
x

𝐴
I = 10 % F= 𝑖 [(1 + 𝑖)𝑁 -1]
𝑋𝑖
I = Pin S= 𝑖
[(1 + 𝑖)𝐿 − 1]
𝑆
I = Xi X=
[(1+𝑖)𝐿 −1]

𝑆
CC = FC + P +
[(1+𝑖)𝐿 −1]

S = the amount needed to replace the property at the end of Useful Life.

i = life if the property in one year

𝑆
Case I: CC = FC + P +
[(1+𝑖)𝐿 −1]

Case II: CC = FC + P
𝑆
Case III: CC = FC + [(1+𝑖)𝐿 −1]
Example 1:

A research laboratory is purchased at 100M and is expected to last 20 years with a replacement
cost of ₱200M. Operation and maintenance expenses are as follows: ₱10M each year for the first 5
years, ₱20M each year for the next 10 years and ₱50M thereafter. If money worth 12%, compute the
capital cost.

Solution:

CC = ?

FC = ₱100M

L = 20 Years

S= ₱200M

I = 12%
𝑆
CC = FC + P +
[(1+𝑖)𝐿 −1]

P=?

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 . . . 20

10M 10M 20M 20M 50M 50M


0/M
𝐴 𝐴 𝐴
𝑃𝐼 = 𝑖 [1 − (1 + 𝑖)−𝑁 ] 𝑃𝐼𝐼 = 𝑖 [1 − (1 + 𝑖)−𝑁 ] 𝑃𝐼𝐼𝐼 = 𝑖

At 0:

P = 𝑃𝐼 + 𝑃𝐼𝐼 (1.12)−5 + 𝑃𝐼𝐼𝐼 (1.12)−15


10000000 20000000 50000000
P=[ 0.12
] [1-(1.12)−5 ] + 0.12
[1 − (1.12)−10 ] (1.12)−5 +
0.12
(1.12)−15

P = 176, 292, 970


200,000,000
CC = 100,000,000 + 176,292,970 + [(1.12)20 −1]

CC = ₱ 299, 424, 270


Example 2:

The will of a wealthy philanthropist left ₱ 5,000,000 to establish a perpetual charitable


foundation. The foundation trustees decided to spend ₱ 1,200,00 to provide facilities immediately and
to provide ₱ 100, 000 of capital replacement at the end of each 5-year period. If the invested funds
earned 12% per annum, what would be the year end amount available in perpetuity from the
endowment for charitable purposes?

Solution:

5M S = 100,000 S = 100,000

0 1 2 3 4 L = 5yrs 6 7 8 9 L = 5yrs 11 12 ∞

FC = 1.2M A A A A A A A A A A A A A

𝑆
X = (1+𝑖)𝐿 −1 i = 10%

𝐴
P= 𝑖

𝑆
CC = FC + P + [(1+𝑖)𝐿 −1]

𝐴 𝑆
CC = FC + 𝑖
+ [(1+𝑖)𝐿 −1]

𝐴 100,000
5,000,000 = 12,000,000 + 0.12 + [(1.12)5 −1]

A = ₱ 440,259.03

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