Question

How is the initial investment in a capital expenditure calculated?

Answer 1

In capital budgeting ascertaining the initial investment is vital to correctly determine if a new project is a viable option. While calculating the initial cost, we take into account all costs which are directly related to the acquisition of the asset. This includes the purchase price, shipping and installation costs and any ancillary costs which are required to bring the asset into the working position.

Besides the cost of the new asset, there are other costs which are incurred such as the opportunity cost that may arise due to undertaking the new project. For example the building which is used for the new project could have been sold if the project had not been undertaken. There may be other cash flows involved in the capital budgeting analysis such as additional working capital required for the new project. There may also be some cash inflow such as sale of old machinery which should be taken into account while calculating initial cash flows.