Capital versus Operating CostsOperating costs are incurred through the operation of physical plant or equipment needed to provideservice, examples include items such as labor and raw materials.Capital costs (capital recovery cost) are incurred by purchasing assets to be used in production and service.Normally capital costs are non recurring (one time) costs, whereas operating costs recur for as long as anasset is owned.Because operating costs recur over the life of a project, they tend to be estimated commonly on an annualbasis, so for the purposes of annual equivalent cost analysis, no special calculation is required. However,because capital costs tend to be one time costs, we must translate this one time cost into its annualequivalent over the life of the project.10. A drinking water treatment system costs $30,000, has a 10-year life and a salvage valueof $6,000. If the firm can earn an after-tax revenue of $5500, should it be purchased atan interest rate of 10%?5

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10. A drinking water treatment system costs of $6.000. If the firm can earn an after-

FINANCIAL ACCOUNTING

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ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

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Concept explainers

Production Budget

A budget can be defined as a financial plan designed by an undertaking for a definite period in the future that can contribute towards enhancing the financial success of the business undertaking. It is used to estimate the revenue and expenses. The budget generally takes into account both current and future income and expenses.

Question

Capital versus Operating Costs
Operating costs are incurred through the operation of physical plant or equipment needed to provide
service, examples include items such as labor and raw materials.
Capital costs (capital recovery cost) are incurred by purchasing assets to be used in production and service.
Normally capital costs are non recurring (one time) costs, whereas operating costs recur for as long as an
asset is owned.
Because operating costs recur over the life of a project, they tend to be estimated commonly on an annual
basis, so for the purposes of annual equivalent cost analysis, no special calculation is required. However,
because capital costs tend to be one time costs, we must translate this one time cost into its annual
equivalent over the life of the project.
10. A drinking water treatment system costs $30,000, has a 10-year life and a salvage value
of $6,000. If the firm can earn an after-tax revenue of $5500, should it be purchased at
an interest rate of 10%?
5

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