User Cost of Capital
= Economic Depreciation + (Interest Rate)(Value of Capital)
- Example
- An Airline buys Boeing 737 for $150 million with the expected life of 30 years
- Annual economic depreciation = $150 /30 million = $5 million
- Interest rate = 10 percent
- User Cost of Capital = $5 million + (.10) ($150 million - depreciation)
- Year 1 = $5 million + (.10)($150 million) = $20 million
- Year 10 = $5 million + (.10) ($100 million) = $15 million
- Rate per dollar of capital
- r = Depreciation Rate + Interest Rate
- Airline Example
- Depreciation Rate = 1/30 = 3.33/yr
- Rate of Return = 10%/yr
- User Cost of Capital
• r = 3.33 + 10 = 13.33%/yr