Section7.34

Section7.34 - Capitalized Cost (section 7.3) We bring up...

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Capitalized Cost (section 7.3) We bring up the notion of physical assets these are assets that are used in the operation of a business these assets have a finite lifetime, after which they must be replaced This section deals with determining a value that represents a sufficient amount of money that, if invested today, would maintain the identical asset in operation forever
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This sum of money is called the capitalized cost of an asset Notation C = original cost/replacement cost of an asset S = salvage or scrap value of asset n = number of years before asset needs to be replaced M = annual maintenance costs i = annual rate of interest i * = equivalent interest rate, compounded once every n-years = (1+ i ) n - 1 K = capitalized cost of asset
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K = present value of current and future costs K = C + 1 ) 1 ( - + - n i S C + i M
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How Can This Be Used to Make Business Decisions? A company may have to choose between two or more assets that are to be used for the same purpose but the original costs, useful lifetime and maintenance costs may be different The company can calculate and compare the capitalized costs of the assets, then choose asset with the lower value of K this is called capital budgeting
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A manufacturer needs to decide between two machines used to produce widgets. Machine 1 Machine 2 Cost $18,000 $25,000 Scrap Value $2,400 $5,000 Lifetime 15 years 20 years Maintenance $1500 $1000 If money is worth j 1 = 10%, which machine should be purchased? Solution to 7.3.1
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Section7.34 - Capitalized Cost (section 7.3) We bring up...

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