Capitalized cost analysis:-

The capitalized cost can also be used for comparison of two or more mutually exclusive alternatives which are assumed to serve perpetually. In this case the comparison of the alternatives is made over same time period i.e. infinite period of time. The alternative that shows lowest capitalized cost is selected as the best alternative.

In the following examples, the calculation of capitalized cost of an alternative and the comparison of mutually exclusive alternatives on the basis of capitalized cost are illustrated.

 Example -18  

The initial cost of an infrastructure development project which is expected to serve residents of a city perpetually is Rs.15000000. The annual operating cost is Rs.800000 for first 10 years and Rs.900000 in the subsequent years (i.e. from year 11 onwards). The expected cost of renovation at the end of every 15 years is Rs.1800000. Find out the capitalized cost of the project at interest rate of 8% per year.

Solution:

The cash flow diagram of the project for a part of service life is shown in Fig. 2.30  

The total capitalized cost of the project is equal to sum of the initial cost and capitalized cost of annual operating cost and renovation cost.

Fig. 2.30 Cash flow diagram of the project

The annual operating cost is Rs.800000 for first 10 years followed by Rs.900000 thereafter. This can be represented as Rs.800000 from end of year 1 to infinite period of time and Rs.100000 from end of year 11 to infinity as shown in Fig. 2.30. Thus the capitalized cost of the annual operating cost is equal to the sum of capitalized cost of these two components.

Capitalized cost of the annual operating cost:

In the above expression, the capitalized cost of Rs.100000 from end of year 11 till infinity is located at the end of year 10. Now the present worth (i.e. amount at time zero) of this amount is calculated by multiplying it with single payment present worth factor.

Capitalized cost = -Rs.10579000