Question

The maintenance of a portion of some capital equipment costs $5000 annually and is expected to be required for a long time. What is the capitalized cost if the interest rate is 5% ?

A) $1000
B) $100,000
C) $500,000
D) $25,000
E) Not enough information

Answer 1

The capitalized cost for annual maintenance of some capital equipment at a 5% interest rate is calculated as a perpetuity and amounts to $100,000, which is option B.

Step-by-step explanation:

The capitalized cost of maintaining capital equipment, considering an annual maintenance cost of $5000 and an interest rate of 5%, can be calculated using the formula for the present value of a perpetuity: Present Value = Annual Cost / Interest Rate. In this case, the perpetuity arises from the expectation that maintenance costs will persist indefinitely.

Substituting the given values into the formula: $5000 / 0.05 = $100,000. Therefore, the capitalized cost, representing the total present value of future maintenance expenses, is $100,000. This calculation aligns with option B, reflecting the accurate determination of the capitalized cost in the context of perpetual maintenance costs and the associated interest rate. Understanding capitalized costs is essential for businesses to assess the long-term financial implications of maintaining capital equipment.