What is a capital project?
– Definition: A capital project is a substantial, long-duration investment to create, expand, or materially improve a capital asset. A capital asset is a long-lived resource (for example, land, buildings, major equipment, roads, bridges, power plants) that is recorded on the balance sheet and depreciated (its cost spread over its useful life).
– Key characteristics: large scale, high cost relative to ordinary expenditures, multi-period planning and execution, capitalized on financial statements, and expected to generate benefits over several years.
Why organizations undertake them
– Businesses use capital projects to increase production capacity, lower unit costs, replace aging equipment, or enter new markets (for example, building a factory or installing a new production line).
– Governments use them to provide or maintain public infrastructure such as highways, water systems, schools, and dams.
Common examples
– Public sector: roads, railways, bridges, subways, pipelines, dams, schools, power plants.
– Private sector: new warehouses, manufacturing equipment, refineries, major facility expansions.
How they’re funded
– Typical funding sources include bonds, grants, bank loans, equity, internal cash reserves, and public budget appropriations. Large public projects often rely on government financing or municipal bonds; private firms may mix debt and equity.
– Note about lender security: lenders usually look to the borrower’s creditworthiness or pledged revenue streams rather than seizing a finished public asset (a bridge, for example, is not typically taken as collateral in the same way as a machine might be).
Risks and success factors
– Capital projects tie up large resources and take time to complete, so poor planning, cost overruns, unrealistic schedules, or funding shortfalls can turn a planned expansion into a loss.
– Key drivers of success: realistic cost and time estimates, secured affordable funding, strong project governance, active risk management, clear measurement of benefits (for example, expected cost savings or added capacity).
Noncapital projects and thresholds
– Many public offices set thresholds to decide whether a planned expenditure is “capital” or “noncapital.” Thresholds can include minimum dollar amounts, minimum added square footage, or minimum useful life. For example, one jurisdiction may treat projects that add at least 5,000 gross square feet or cost more than $3 million as capital projects; smaller or shorter-lived efforts are labeled noncapital.
Practical checklist for evaluating a capital project
1. Define the objective: What capacity, cost reduction, or service improvement is expected?
2. Scope and specification: Detail the required assets, technologies, and lifecycle assumptions.
3. Estimate total cost: construction/purchase, installation, contingency, and operating changes.
4. Secure funding: identify mix of debt, equity, grants, or retained earnings and confirm availability.
5. Financial appraisal: calculate expected returns (see worked example below) and compare to hurdle rate (e.g., weighted average cost of capital).
6. Regulatory & legal review: permits, approvals, and public consultation (if applicable).
7. Risk register & mitigation: schedule, cost, supply-chain, regulatory, and demand risks.
8. Governance and monitoring: appoint owners, set milestones, and establish reporting.
9. Procurement and contracting: choose delivery model (design-bid-build, design-build, PPP, etc.).
10. Post-implementation review: measure actual benefits vs. projections and capture lessons.
Worked numeric example: simple RONIC and depreciation
Assumptions
– Project cost (new equipment and installation): $10,000,000 (capitalized).
– Expected incremental annual operating profit (before tax): $1,500,000.
– Useful life for accounting depreciation: 20 years.
– Company’s hurdle rate (discount/WACC used for decision): 8% (assumption).
Calculations
1. Straight-line depreciation per year = cost ÷ useful life
= $10,000,000 ÷ 20 = $500,000 per year (non-cash accounting expense).
2. Simple