Chapter 4 Capitalized Cost

Capitalized Cost
CAPITALIZED COST
CALCULATION AND ANALYSIS
Capitalized cost (CC) is the present worth of an alternative that will last "forever.“
Public sector projects such as bridges, dams, irrigation systems, and railroads fall
into this category.
Formula to calculate Capitalized Cost
The formula to calculate CC is derived from the relation
P = A(P / A , i , n), where n = ∞.
Mathematically, the amount A of new money generated each consecutive interest
period for an infinite number of periods is,
A= Pi = CC(i)
The cash flows (costs or receipts) in a capitalized cost calculation are usually of two
types: recurring, also called periodic, and nonrecurring.
An annual operating cost of $50,000 and a rework cost estimated at $40,000 every 12
years are examples of recurring cash flows.
Examples of nonrecurring cash flows are the initial investment amount in year 0 and
one-time cash flow estimates at future times, for example, $500,000 in technology
calibration and upgradation.
Procedure
1. Draw a cash flow diagram showing all nonrecurring (one-time) cash flows and at
least two cycles of all recurring (periodic) cash flows.
2. Find the present worth of all nonrecurring amounts. This is their CC value.
3. Find the equivalent uniform annual worth (A value) through one life cycle of all
recurring amounts. This is the same value in all succeeding life cycles.
4. Add this to all other uniform amounts occurring in years 1 through infinity and
the result is the total equivalent uniform annual worth (AW).
5. Divide the AW obtained in step 4 by the interest rate i to obtain a CC value.
6. Add the CC values obtained in steps 2 and 5.

Solved Problems
1. An engineering school has just completed a new engineering complex
worth $50 million. A campaign targeting alumni is planned to raise
funds for future maintenance costs, which are estimated at $2 million
per year. Any unforeseen costs above $2 million per year would be
obtained by raising tuition. Assuming that the school can create a trust
fund that earns 8% interest annually, how much has to be raised now to
cover the perpetual string of $2 million in annual costs?
Soln:
Given A= $ 2 million , i= 8% and N = ∞
Find : CE (8%)
The Capitalized cost equation is
CE (i) = A/i CE(8%) = $ 2,000,000 / 0.08 = $ 25,000,000

Example 1:
The property appraisal district for Marin County has just installed new
software to track residential market values for property tax computations.
The manager wants to know the total equivalent cost of all future costs
incurred when the three county judges agreed to purchase the software
system. If the new system will be used for indefinite future, find the
equivalent value (a) now and (b) for each year hereafter. The system has an
installed cost of $150,000 and an additional cost of $50,000 after 10 years.
The annual software maintenance contract cost is $5000 for the first 4 years
and $8000 thereafter. In addition, there is expected to be a recurring major
upgrade cost of $15,000 every 13 years. Assume that i = 5% per year for
county funds.
2. To decrease the costs of operating a lock in a large river, a
new system of operation is proposed. The system will cost
$8,30,000 to design and build. It is estimated that it will have
to be reworked every 20years at a cost of $1,20,000. In
addition, an expenditure of $80,000 will have to be made at
the end of the fifth year from now for a new type of gear that
will not be available until then. Annual operating costs are
expected to be $70,000 for the first 15 years and $1,00,000
every year thereafter. Compute the capitalized cost at i=7%.
3. A newly constructed bridge costs $15,00,000.
the same bridge is estimated to need renovation
every 15years at a cost of $3,00,000. annual repair
and maintenance cost are estimated to be $
1,00,000 per year. If the interest rate is 5%,
determine the CC of the bridge.
 Two large-scale conduits are under consideration by a large
municipal utility district (MUD). The first involves
construction of a steel pipeline at a cost of $225 million.
Portions of the pipeline will have to be replaced every 40
years at a cost of $50 million. The pumping and other
operating costs are expected to be $10 million per year.
Alternatively, a gravity flow canal can be constructed at a
cost of $350 million. The M&O costs for the canal are
expected to be $0.5 million per year. If both conduits are
expected to last forever, which should be built at an interest
rate of 10% per year?

Chapter 4 Capitalized Cost

Uploaded by

Copyright:

Available Formats

Chapter 4 Capitalized Cost

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Chapter 4 Capitalized Cost

Uploaded by

Copyright:

Available Formats

Capitalized Cost

least two cycles of all recurring (periodic) cash flows.

the result is the total equivalent uniform annual worth (AW).

5. Divide the AW obtained in step 4 by the interest rate i to obtain a CC value.

6. Add the CC values obtained in steps 2 and 5.

CE (i) = A/i CE(8%) = $ 2,000,000 / 0.08 = $ 25,000,000

You might also like