Question

Economic Profit Problem 8. 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? 7:53 PM

Answer 1

Ans (a). Depreciation Allowance = $10,000,000 / 10 years = $1,000,000

Ans (b). Opportunity cost if the firm uses the rig = the cost of next best alternative forgone. = $1,100,000

Ans (c). True cost to the firm for using the rig = $10,000,000 - $5,500,000 = $4,500,000