Costs for Capital Budgeting Analysis

Learning Outcomes

  • Understand operating and implementation costs in a capital budgeting analysis

Man looking at analytics on a tabletIn 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 four 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 1: 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:

Capital Investment
Description Amount
Van $  35,000
Cargo lift/Custom paint       5,000
Sales tax at 8%       3,200
Vehicle registration           600
Single Line$  43,800Double line


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

Annual Cash Flows
YR 1 YR 2 YR 3 YR 4
Fuel $    8,000 $   8,000 $   8,000 $   8,000
Maintenance       1,000       2,000       3,000       4,000
Repairs             –             –       4,000             –
Tires/etc.           750           750           750           750
  Total cash out Single Line$    9,750Double line Single Line$  10,750Double line Single Line$  15,750Double line Single Line$  12,750Double line
Delivery Revenue $   26,000Double line $  26,000Double line $  26,000Double line $  26,000Double line

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

Practice Question