Question

customers. The DVD player cost $500, and you depreciate the machine at a rate of 25% each year. You can borrow money from the bank at 10%, or receive 6% for depositing money at the bank. The expected inflation rate in the coming year is 5%. You used the company's own funds to purchase the DVD player. The firm's user cost of capital for the first year is $130. $150. $155. $175.

Answer 1

User cost of capital = $130

so correct option is $130

Step-by-step explanation:

given data

DVD player cost = $500

Depreciation = 25%

interest rate = 6%

Expected inflation rate = 5%

solution

we find here first Expected real interest rate that is express as

Expected real interest rate = Deposit rate - Expected inflation rate

Expected real interest rate = 6% - 5%

Expected real interest rate = 1%

and

now Calculate the foregone interest that is

Foregone interest = DVD player cost × Expected real interest rate

Foregone interest = $500× 0.01

Foregone interest = $5

and

now find the depreciation that is

Depreciation = Cost of DVD player × Depreciation rate

Depreciation = $500 × 0.25

Depreciation = $125

so user cost of capital will be here

User cost of capital = Foregone interest + Depreciation

User cost of capital = $5 + $125

User cost of capital = $130

so correct option is $130