1) Suppose that you have been placed in charge of calculating the user cost of capital for a corporation. You know that capital costs are debt-financed at the margin and you have the following additional information (the time period is a year, and all percentages have been translated into fractions, i.e., a 10% interest rate is written as .1):
before-tax interest rate paid by the corporation = .1
depreciation rate (denoted δ in class) = .05
a) In the absence of taxes, what is the user cost of capital? (Give a number, and make sure that you show all of your calculations.)
For the remaining questions, assume that corporate income is taxed at a 50% rate. (Assume no investment tax credits.)
b) If the firm is allowed no tax deductions for any of the costs associated with capital investments, then what is the user cost of capital?
c) If the firm is allowed to deduct both interest payments and actual economic depreciation from its taxable income, then what is the user cost of capital?
(d) If the firm is allowed to expense its capital investments but is not allowed to deduct interest payments, then what is the user cost of capital?