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