Cost Benefit Analysis
One significant dimension of a capital budget analysis is making trade offs, or a cost benefit analysis of the various options.
For example, in the capital budget example of farm operations mentioned above, one trade off would be between buying a new tractor or a used tractor.
An used John Deere 2040 tractor might cost $4,000 as opposed to about $22,000 for a brand new tractor of the same model. Assuming the used tractor requires repairs worth $4,000 to make it operational, the trade off is between $22,000 for a new tractor and $8,000 for a used tractor.
The used tractor incurs higher annual maintenance costs, however. Assume the used tractor incurs a maintenance cost of $2,100 per year versus the $100 maintenance cost for the new tractor covered by warranty. The savings in capital on buying a used tractor, $22,000 - $8,000 = $14,000 comes at $2,100 - $100 = $2,000 annual maintenance costs for the used tractor.
If the additional capital of $14,000 required for the new tractor returns more than $2,000 per annum, or 14.2 percent, purchasing a used tractor is the better option. If the cost of capital is less than 14.2 percent, or $14,000 deployed elsewhere returns less than $2,000 per annum, a better use of the capital is to purchase a new tractor rather than the old tractor.
In actual life, factoring deprecation or life of the new and old tractor complicates the equation.