In the prior section, we broke the capital budgeting process into three phases, each with three steps:

Phase 1 – Screening

1. Begin with the larger picture
2. Identify and evaluate potential opportunities
3. Screen opportunities

Phase 2 – Analysis

1. Estimate operating and implementation costs
2. Estimate cash flow
3. Assessment

Phase 3 – Implementation

1. Select the project
2. Implement the project
3. Re-evaluate the decision

Let’s dive a bit deeper into Phase 2: Preparing a Capital Budgeting Analysis.

To illustrate the steps in capital budgeting analysis, we will use a hypothetical example of the purchase of a small van to be used by Cynthia Becker for making local, short-haul deliveries–the portion of the trip that online retailers call the “last mile”. Becker plans to acquire the van, use it for 4 years and then sell it for fair value on the resale market. She plans to use the sales proceeds as a down payment on a replacement van at that time.

She started with Phase 1, step 1 when she established her business and her strategic plan. For step 2, she looked at her needs as an independent delivery service and made a list of different vehicles she could use. In step 3, she settled on a particular van. Now she moves into Phase 2.

Phase 2–Step 4: Estimate operating and implementation costs.

Implementation costs are the total initial investment, which is the total cost of the asset being acquired, or the total investment necessary to fund the project. In our example, Becker has estimated total costs to be:

For Becker’s capital investment project, she has projected the following costs:

Now, check your understanding of estimating operating and implementation costs.