Economics: Private and Public Choice (MindTap Course List)
Economics: Private and Public Choice (MindTap Course List)
16th Edition
ISBN: 9781305506725
Author: James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson
Publisher: Cengage Learning
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Chapter 27, Problem 13CQ
To determine

Check whether buying of a refrigerator is profitable or not.

Expert Solution & Answer
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Explanation of Solution

The market value of a product is determined by its present value. With the given information, the buying price (P) of a refrigerator is $700, the salvage value (SV) is $200, rate of interest is 8 per cent, and reduction in the electricity bill (ED) is $150. Assume that the electricity bill is $350. After deducting the ED, electricity bill is $200(350150). The present worth (PV) of using the owner’s refrigerator can be calculated as follows:

PV=EB1(1+i)1EB2(1+i)2...EBn(1+i)n=350(1+0.08)1350(1+0.08)2350(1+0.08)3350(1+0.08)4350(1+0.08)5=350(1.08)1350(1.08)2350(1.08)3350(1.08)4350(1.08)5=3501.083501.16643501.25973501.36053501.4693=324.07300.07277.84257.26238.21=1,397.45

The PV of using the owner’s refrigerator is -$1,397.45.

The present worth (PV) of buying a new refrigerator can be calculated as follows:

PV=PEB1(1+i)1EB2(1+i)2...EBn(1+i)n+SVn(1+i)n=700200(1+0.08)1200(1+0.08)2200(1+0.08)3200(1+0.08)4200(1+0.08)5+200(1+0.08)5=700200(1.08)1200(1.08)2200(1.08)3200(1.08)4200(1.08)5+200(1.08)5=7002001.082001.16642001.25972001.36052001.4693+2001.46693=700185.185171.468158.768147136.119+136.119=1,362.42

The PV of buying a new refrigerator is -$1,362.42. Thus, PV of buying a new refrigerator is greater (lower cost) than using the owner’s refrigerator. Thus, the person chooses to buy a new one.

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