Question

Luxury Air models cost $510, result in electricity bills of $104 per year, and last for...

Luxury Air models cost $510, result in electricity bills of $104 per year, and last for 8 years. The discount rate is 22%.

a) Now you remember that the inflation rate is expected to be 10% per year for the foreseeable future. What are the equivalent annual costs of Luxury Air models?

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Answer #1

Real discount rate= (i-f)/(1+f)

Where,

i= nominal discount rate

f= inflation rate

Real discount rate=(22-10)/(1+.10)

Real discount rate=(12)/(1.10)

Real discount rate=10.90%

Equivalent annual cost=(NPV/ present value of annuity factor)+Annual maintenance cost

Present value of annuity factor =[1-(1/(1+r)t)]/r

[1-(1/(1+.1090)8)]/.1090

[1-(1/ 2.2879)]/.1090

[1-( 0.437066)]/.1090

[0.562933]/.1090

5.16452

Equivalent annual cost= (510/5.16452)+104

Equivalent annual cost= (98.75070)+104

Equivalent annual cost= $202.75070(Ans.)

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