Question

K firm own a drilling rig that purchased for $10 million. The life of a drilling rig is 10 years, and your accountants use straight-line depreciation. It’s the start of the year, and the current market value of the rig is $6 million, so you can sell it to another driller for $6 million. If you sell the rig, you can use the funds in an investment that returns a profit of 10%. Alternatively, you can rent the rig using a triple net lease to another developer for this year for $1.1 million. At the end of the year, the rig will be worth $5.5 million.

a. what is the depreciation allowance?

b. What is your opportunity cost if your firm uses the rig?

c. What is the true cost to your firm of using the rig?

Answer 1

8 a. what is the depreciation allowance? 10 10,000,000 Purchase Price of the drilling ring (A) Life of drilling rig (B) Depreciation allowance (A/B) 1,000,000 b. What is your opportunity cost if your firm uses the rig? Current market value of the rig (A) % of Profit on Investment (B) Amount of Profit received from Selling (A *B) = (C) Value at the end of the Year (D) Depression on rig (A-D)=(E) If it is leased to another developer (F) Opportunty Cost (F-E) 6,000,000 10% 600,000 5,500,000 500,000 1,100,000 600,000 24 c. What is the true cost to your firm of using the rig? In this case ,true cost is the opportunty cost since it is highest . So the true cost is 600000