Question

Calculate the user cost of capital of a machine that costs $100,000 and depreciates at a rate of 25%, when the nominal interest rate is 4% and the expected inflation rate is 1%.

(a) $3000

(b) $25,000

(c) $28,000

(d) $29,000

Answer 1

Solution:-

Cost of Capital = Cost of the Machinery * (Real Interest Rate + Depreciation Rate)

Cost of the Machinery = $100,000

Real Interest Rate = 3%

Depreciation Rate = 25%

Real Interest Rate = Nominal Interest Rate - Inflation Rate

                              = 4% - 1%

                              = 3%

Cost of Capital = $100000 * (25% + 3%)

                         = $100000 * 28%

                          = $28000

Correct answer is option (C) $28,000