Question

On EXCEL

1-You are going to buy a $350,000 building in cash and will depreciate the asset over 30 years. Assume the building value will increase 2% per year each year for 20 years. If inflation is constant at 2.2% per year, what is the opportunity cost of the building?

2. You give a loan to your friend to buy equipment for his business. The friend puts $4000 of their own money as a down payment, you lend them $12,000. The equipment is $16,000 total. You will charge your friend 4.0% Interest every year and will collect monthly payments for 60 months. Inflation is 1.7% per year, constant for 5 years.

2a. What is the monthly payment you will collect?

2b. What is the total amount of payments you will collect?

2c. What is the vehicle worth at the end of the loan term if it depreciates in value at $150 each month?

2d. What is the NPV of the loan assuming it is paid each month on time?

2e. What is the opportunity cost of the loan you give to your friend if you could invest the same amount and receive a 4.5% return each month?

2f. Given the opportunity cost would you lend your friend the money?

3-Your business is looking to invest $20,000 in a new work truck. The truck will last about 10 years and will have a second hand resale value of $2000 after its useful life for parts to other owners. Assume inflation is a 2% constant.

3a What is the opportunity cost of the truck if you simply just don't buy it? What other items might need to be considered to further evaluate this?

3b If i told you the truck would also cost $1500 per year in maintenance how would the opportunity cost change?

3c Do not include the maintenance costs in 3b and calculate both the net cost and the opportunity cost of the truck if it produces $1000 per year in income for your business.  

Answer 1

1. Following are the data given in the question.

Cost of house	$350,000
Depreciation	30	years
Value appreciation	2%	every year for 20 years
Inflation	2.20%

Opportunity cost :- opportunity cost is the missed benefits of an individual, investor, business misses out on when choosing one alternative over other.

Formula for calculating opportunity cost will be:- Return on best foregone option - Return of chosen option.

Here we have to adjust the inflation in the return to get the final return.

The formula for inflation adjusted return is:-

so by implementing the above formula, we get inflation adjusted return as

Cost of house	$350,000
Depreciation	30	years
Value appreciation	2%	Every year for 20 years
Inflation	2.20%
Inflation adjusted return	-0.20%

In the above case, The return is negative. so the opportunity cost for this case will be 0.2% because the investor is losing money on above investment. If the investor did not invest on the above investment, he would not have lost that money.

2. Following are the data extracted from the question:

Down payment	$4,000
Loan	$12,000
interest	4%	p.a
Tenure	60	months

a. What is the monthly payment you will collect?

Formula for calculating EMI

By putting above formula, we get EMI as $221

b. Total amount to be collected: $13259

c. what is the vehicle worth at the end of the loan term if it depreciate in value at $150 each month will be $3000.

Down payment	$4,000
Loan	$12,000
interest	0.33%	p.a
Tenure	60	months
Dep	$150
EMI	$221.00
Total Depreciation	$9,000
Total Interest Paid	$1,259.90

d. NPV of loan (assuming EMIs are being paid on time)

Down payment	$4,000
Loan	$12,000
interest	0.33%
Tenure	60
Dep	$150
EMI	$221.00
Total Depreciation	$9,000
Total Interest Paid	$1,259.90
NPV	$220.26

e. Opportunity Cost at 4.5%

			Opportunity Cost
Down payment	$4,000	$4,000
Loan	$12,000	$12,000
interest	0.33%	0.38%	=4.5%/12
Tenure	60	60
Dep	$150	$150
EMI	$221.00	$223.72
Total Depreciation	$9,000	$9,000
Total Interest Paid	$1,259.90	$1,422.97	$163.08
npv	$220.26	$222.88

F. No, I would not lend him at 4% but 4.5%.

3. a. Instead of buying a truck the investor can invest his money in number of ventures such as

• Stocks
• Mutual funds
• Bonds
• treasury bonds
• any other profitable business

b. By adding $1500 in maintenance cost, the opportunity cost will be increased by $1500.

c. Net cost for the truck will be negative of $800 as depreciation charged as $1800.