Capitalized Cost

Capitalized Cost
The Capitalized Cost of any structure or property is the sum of its
first cost and the present worth of all costs for replacement,
operation, and maintenance for a long time or forever.
The Annual Cost of any structure or property is the sum of the
annual depreciation cost, interest of the first cost and the annual
operating and maintenance costs.

Annual Cost = Annual Depreciation Cost + Interest of the First

Cost + Annual Operating and Maintenance Cost
 Capitalized Cost
Case 1. No replacement, only maintenance and or operation every
period.

CC = FC + PW of perpetual operating and or maintenance

1. Determine the capitalized cost of a structure that requires an initial

investment of P1,500,000 and an annual maintenance of
P150,000. Interest is 15%.
 Capitalized Cost
Case 2. Replacement only, no maintenance and or operation.

CC = FC + PW of Perpetual Replacement

= ( , %, )

S : amount needed to replace a property every k period

X : amount of principal invested at rate i% the interest on which will
amount to S every k periods
Xi : interest on X every period, the periodic deposit towards the
accumulation of S
 Capitalized Cost
Case 2. Replacement only, no maintenance and or operation.

1. A new engine was installed by a textile plant at a cost of P300,000

and projected to have a useful life of 15 years. At the end of its
useful life, it is estimated to have a salvage value of P30,000.
Determine its capitalized cost if interest is 18% compounded
annually.
 Capitalized Cost
Case 3. Replacement, maintenance and or operation every period.

CC = FC + PW of cost of perpetual operation and or

maintenance + PW of cost of perpetual replacement

1. Determine the capitalized cost of a research laboratory which

requires P5,000,000.00 for original construction; P100,00.00 at
the end of every year for the first 6 years and then P120,000.00
each year thereafter for operating expenses, and P500,000
every 5 years for replacement of equipment with interest at
12% per annum?
 Exercises
1. The first cost of a certain equipment is P324,000 and a salvage
value of P50,000 at the end of its life of 4 years. If money is worth
6% compounded annually, find the capitalized cost.
2. An item is purchased for P100,000. Annual cost is P18,000. Using
interest rate of 8%, what is the capitalized cost of perpetual
service?
3. At 6%, find the capitalized cost of a bridge whose cost is P250M
and life 20 years, if the bridge must be partially rebuilt at a cost of
P100M at the end of each 20 years.
 Exercises
1. Make an economic analysis to determine which of the following
two machines capable of performing the same task in a given
amount of time, should be purchased. The minimum attractive
return is 8%.
Machine A Machine B
First Cost P10,000 P20,000
Estimated Life 6 years 14 years
Salvage Value 0 P6,000
Annual Maintenance P250 P300

Basing on the annual cost, using straight line method of

depreciation, determine which machine you would choose and how
much is the difference in their annual costs?
 Exercises
1. Calculate the capitalized cost of a project that has an initial cost of
P3,000,000 and an additional investment cost of P1,000,000 at
the end of every ten years. The annual operating cost will be
P100,000 at the end of every year for the first four years and
P160,000 thereafter. In addition, there is expected to be a
recurring major rework cost of P300,000 every 13 years. Assume i
= 5%.
2. The surface area of a certain plant that requires painting is 8,000
sq. ft. Two kinds of paint are available whose brands are A and B.
Paint A costs P1.40 per sq. ft but needs renewal at the end of
every 4 years, while paint B costs P1.80 per sq. ft. If money is
worth 12% effective, how often should paint B be renewed so
that it will as economical as Paint A?
QUIZ
1. An engineering school has just completed a new engineering
complex worth Php50 million. A campaign targeting alumni is
planned to raise funds for future maintenance costs, which are
estimated at Php1.5 million per year. Any unforeseen costs
above Php1.5 million per year would be obtained by raising
tuition. Assuming that the school can create a trust fund that
earns 4.5% interest annually, how much has to be raised now to
cover the perpetual string of Php1.5 million annual costs?
QUIZ
2. An asset is purchased for P120,000.00. Its estimated
economic life is 10years, after which it will be sold for
P12,000.00. Find the depreciation for the first year using SYD
method.
3. An engineer bought an equipment for P500,000.00. Other
expenses including installation amounted to P30,000. At the end
of its estimated useful life of 10 years, the salvage value will be
10% of the first cost. Using straight line method of depreciation,
what is the book value after 5 years?
QUIZ
4. Calculate the capitalized cost of a project that has an initial
cost of P3M and an additional investment cost of P1M at the
end of every ten years. The annual cost will be P100K at the end
of every year for the first four years and P160K thereafter. In
addition, there is expected to be a recurring major rework cost
of P300K every thirteen years. Assume that interest rate is 15%.
Capital Financing
 Capital
Wealth owned by a person or organization invested, lent, or
borrowed.

1. Equity Capital / Ownership Funds

Those supplied and used by the owners of an enterprise in the
expectation that a profit will be earned.
2. Borrowed Funds or capital
Those supplied by others on which a fixed rate of interest must be paid
and the debt must be repaid at a specified time.
 Forms of Business Organizations
1. Individual Ownership / Sole Proprietorship
2. Partnership
3. Corporation
4. Limited Liability Company (LLC in USA)
5. Cooperative
 Forms of Business Organizations
1. Individual Ownership / Sole Proprietorship
A person uses his or her own capital to establish a business and is the
sole owner.
Usually adopted by small business entities.
2. Partnership
3. Corporation
4. Limited Liability Company (LLC in USA)
5. Cooperative
 Forms of Business Organizations
1. Individual Ownership / Sole Proprietorship
2. Partnership
An association of two or more persons for the purpose of engaging in a
business for profit.
3. Corporation
4. Limited Liability Company (LLC in USA)
5. Cooperative
 Forms of Business Organizations
1. Individual Ownership / Sole Proprietorship
2. Partnership
3. Corporation
It is a distinct legal entity, separate from individuals who own it, and
which can engage in almost any type of business transaction.
Ownership in a stock corporation is represented by shares of stock.
4. Limited Liability Company (LLC in USA)
5. Cooperative
 Forms of Business Organizations
1. Individual Ownership / Sole Proprietorship
2. Partnership
3. Corporation
4. Limited Liability Company (LLC in USA)
Hybrid form of business that has characteristics of both a corporation
and a partnership.
It is no incorporated; hence, it is not considered a corporation.
An LLC may elect to be taxed as a sole proprietorship, a partnership, or
a corporation.
5. Cooperative
 Forms of Business Organizations
1. Individual Ownership / Sole Proprietorship
2. Partnership
3. Corporation
4. Limited Liability Company (LLC in USA)
5. Cooperative
A business organization owned by a group of individuals and is
operated for their mutual benefit.
The persons making up the group are called members.
Cooperatives may be incorporated or unicorporated.
 Corporation
Principal Types of Stock
1. Common Stock
Represents ordinary ownership without special guarantee of return.
Common stockholders have certain legal rights.
2. Preferred Stock
Preferred Stockholders are guaranteed a definite dividend on their
stocks.
In case the corporation is dissolved, the assets must be used to satisfy
the claims of the preferred stockholders before those of the holders of
the common stock.
 Bonds
Is a certificate of indebtedness of a corporation usually for a period
not less than ten years and guaranteed by a mortgage on certain
assets of the corporation of its subsidiaries.
It is a financial security note issued by businesses or corporations
and by the government as a means of borrowing long-term fund.
It may also be defined as a long-term note issued by the lender to
the borrower stipulating the terms of repayment and other
conditions.
Are issued when there is need for more capital such as for
expansion of the plant or the services rendered by the corporation.
 Bonds
It does not represent ownership of a business or corporation and
therefore not entitled to share of the profits.
Raising capital through issuing bonds is called long-term debt
financing.
 Bonds
Face Value
Par Value
The par value of a bond is the amount stated on the bond.
When the face value has been repaid, the bond is said to have been
retired or redeemed.
Bond Value
The value of the bond is the present worth of all the amounts the
bondholder will receive through his possession of the bond.

The bond rate is the interest rate quoted on the bond.

 Classification of Bonds
1. Registered Bonds
The name of the owner of this bond is recorded on the record books of
the corporation and interest payments are sent to the owner
periodically without any action on his part.
2. Coupon Bonds
Have coupon attached to the bond for each interest payment that will
come due during the life of the bond. The owner of the bond can
collect the interest due by surrendering the coupon to the offices of
the corporation or at specified banks.
 Methods of Bond Retirement
1. The corporation may issue another set of bonds equal to the
amount of bonds due for redemption.
2. The corporation may set up a sinking fund into which periodic
deposits of equal amount are made. The accumulated amount in
the sinking fund is equal to the amount needed to retire the bonds
at the same time they are due.
 Bond Retirement by Sinking Fund

= , %,
=
A : periodic deposit to the sinking fund
F : accumulated amount, the amount needed to retire the bond
i : rate of interest in the sinking fund
r : bond rate per period
I : interest on the bonds per period
A + I : total periodic expense
 Exercise
1. A bond issue of P200,000 in 10-year bonds, in P1,000 units,
paying 16% nominal interest in semiannual payments, must
be retired by the use of a sinking fund that earns 12%
compounded semiannually. What is the total semiannual
expense?
 Bond Value

= , %, + ( , %, )

F : face or par value

C : redemption or disposal price (often equal to F)
r : bond rate per period
n : number of periods before redemption
i : investment rate or yield per period
P : value of the bond n periods before redemption
 Exercises
1. A man wants to make 14% nominal interest compounded
semiannually on a bond investment. How much should the
man be willing to pay now for a 12%, P10,000-bond that will
mature in 10 years and pays interest semiannually?
2. A man was offered a Land Bank certificate with a face value
of P100,000 which is bearing interest of 6% per year payable
semiannually and due in 15 years. If he want to earn 8%
semiannually, how much must he pay the certificate?
 Assignment
1. A local firm is establishing a sinking fund for the purpose
of accumulating a sufficient capital to retire its
outstanding bonds at maturity. The bonds are
redeemable in 10 years and their maturity value is
P150,000.00. How much should be deposited each year
if the fund pays interest at the rate of 3%?
2. A P1,500-bond which will mature in 10 years and with a
bond rate of 15% payable annually is to be redeemed at
par at the end of this period. If it is sold now for P1,390,
determine the yield at this price.
 Assignment
3. A P1,000, 6% bond pays dividend semiannually and will be
redeemed at 110% on June 21, 2004. It is bought on June 21,
2001 to yield 4% interest. Find the price of the bond.
4. A company has issued 10-year bonds, with a face value of
P1,000,000, in P1,000 units. Interest at 6% is paid quarterly.
If an investor desires to earn 20% nominal interest on
P100,000 worth of these bonds, what would the selling price
have to be?