Tag Archives | capital project

Opportunity Cost Article

See Also:
Opportunity Costs
Capital Budgeting Methods
Opportunity Costs In Your Decision Making

Opportunity Cost Decision Making

An opportunity cost is a hypothetical cost incurred by selecting one alternative over the next best available alternative. Opportunity costs are relevant in business decision making. In addition, companies commonly use them when evaluating corporate projects.

Opportunity Cost Analysis

When evaluating a potential investment, include opportunity costs in the analysis.

For a capital investment project, a company should evaluate the expected return of the investment compared to the opportunity cost. Opportunity costs are also the expected returns of an alternative investment of equal risk. If you expect the project to yield returns above the opportunity cost, then it may be a good investment.

For example, imagine a company is currently renting out a warehouse. Then the company considers an investment that requires that warehouse. When evaluating the project, the company needs to consider the value of the rent it will no longer be receiving by using the warehouse in the new project. Then, subtract that value from the expected value of the project.

The concept also applies to investing in securities. For example, if an investor takes money out of a savings account to invest it in government bonds, then the investor should consider the opportunity cost of the interest the money would have earned in the savings account. They should especially do this when evaluating the expected returns from investing the money in bonds.

Opportunity Cost in Economics

In economics, opportunity cost is any utility foregone by choosing one alternative over another. Furthermore, it does not necessarily refer to a monetary amount. When you are faced with two desirable and mutually exclusive choices, consider the value of the option not chosen an opportunity cost. For example, an opportunity cost refers to the satisfaction an individual would get from the leisure time that is sacrificed for time spent working. Or if an individual decides to leave a salaried job to go back to school, then the salary given up would be considered an opportunity cost.

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Opportunity Cost Decision Making

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Capitalization Rate Example

See Also:
Capitalization Rate
General Ledger Reconciliation and Analysis
Valuation Methods
Shareholders Equity
Planning Your Exit Strategy
Mergers and Acquisitions

Capitalization Rate Example

John started a real estate company in Indiana. His company has recently begun operations and is beginning to make money. John now wants to strengthen his business; to do this requires the best understanding of the company and it’s working environment. John wants to know the capitalization rate of his company as a whole. This includes net operating income and costs for the financials of the entity.

John speaks with his accountant and finds the data to calculate his capitalization rate. With this, he can find his answer.

Net income = $1,000,000 Cost = $250,000

Capitalization Rate = $100,000 / $250,000 = 4

John knows that his capitalization rate is 4. Next, he speaks with his accountant. He finds that, for this industry, John is doing fairly well for himself. He can use the net income, beyond cost of the bank loan he took, to pay down his loan and begin expanding the company on cash flow. This has immense benefits for both John’s growth and profit potential. John begins to compare the capitalization rate with the discount rate that banks take to create expectations for his next capital project.

He is very happy to hear this. John can now find out how he will use the money rather than worrying about what he will do to please his banker. With the future in sight, he can become a forward thinking business owner.

Conclusion of Capitalization Rate Example

By developing a better understanding about his company, John is more likely to be running a successful and profitable company. The capitalization rate is a good indicator of the overall capabilities of the company. By utilizing the capitalization rate, John now has the overall profits of the company compared with the overall costs of the company. The ratio created is useful for John because it shows that the overall profits of the company is four times that of the overall costs. As said above, John now knows that he can now concentrate on expenditures of money because his capitalization rate is so positive.

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Capital Project

See Also:
Cash Flow Projections
Return on Capital Employed (ROCE)
Return on Invested Capital (ROIC)
Paid in Capital (APIC)

Capital Project Definition

A capital project, defined as any project which requires capital flows for completion, usually refers to a project which requires large sums of capital. It is generally any project which requires consistent flow and management of capital to ensure successful completion. Due to this fact, an example of a project would be the building of a sky scraper, creation of an oil pipeline, or in the context of government, the building of a highway system. Capital project analysis is a constant struggle in works or large scale.

Capital Project Explanation

A capital project, explained sometimes as a function of “big” government or business, requires excellent skills of project management. If a sky scraper were to be built, a management team would have to be put in place. Materials, subcontractors, government permits, and many other issues would have to be solved for everything to receive a finishing touch. For this reason, capital project management must be executed to a “T”. There must be a team of human resources for every sub project, say permits and compliance. In this way, a capital project justification starts from an initial opportunity and flows from the initial founder to the detail oriented specialist. Obviously, this would require large amounts of capital.

Capital Project Example

Vince is the owner of a large commercial real estate firm. He has grown his success, over time, and now owns buildings in many major cities. Vince wants to see where his luck will take him. Essentially, Vince works on capital project planning all day long.

Vince starts by creating a plan. Once he has decided how he will finance, build, and market the building he steps into action. He begins by speaking with an investment banker. To keep it all in place, he begins the process of capital project accounting now by hiring an accounting team as soon as possible.

Vince has used the connection he has with an investment banker to receive funds from the investment branch of a major corporation. Only a company of massive size will be able to assist in an operation this large. He will need to control his capital project fund carefully to ensure a smooth process.

Vince begins the next project by speaking with an architect. The company he finds eventually provides blueprints and referrals to quality contracting companies.

Vince knows he has his work cut out for him. Still, he appreciates growing the scale of his work. Vince wants to challenge his boundaries and sees this as an excellent opportunity. Though Vince has a lot of stress at work, he leaves every day with a smile.

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