0000004087 00000 n This relationship between Assets, Capital and Liabilities is called the Accounting Equation or the Balance Sheet Equation.In general, the expression Assets = Capital + Liabilities is termed as the Accounting Equation, but you can use any of the above relationships till the time you understand the fundamentals of the equation.. Internal equity from the firm or the firm’s owners also has a cost. The tax system effectively taxes the net (after depreciation) return to investment, r q s q s. In this case, new and old capital receive the same present value of depreciation allowances per unit of capital, so the new and … is potentially different from p K); (b) an additional term related to the savings on adjustment-costs as capital increases (the term in C K). (a) How does the arbitrage equation change in the presence of the investment tax credit. Let r is the price or user cost of capital and p is the price of output. Expected after tax real interest rate (equation and definition) rate of return expected by a saver following taxes on interest income r = (1-T)i-(3.14^e) �x@�*�)A0���� �7��/�0,/�]��H_���e�.a�|�YP��Tl�����f�� �iZV�vJ����4g�$l8��8��Y�a8��e=r�z!���e. 93 0 obj << /Linearized 1 /O 95 /H [ 1181 689 ] /L 303727 /E 123495 /N 24 /T 301749 >> endobj xref 93 37 0000000016 00000 n trailer << /Size 130 /Info 91 0 R /Root 94 0 R /Prev 301739 /ID[<9a0fe93e1252d571a284ccb29540fcdc><88640264051f08631827d2eada8777d2>] >> startxref 0 %%EOF 94 0 obj << /Type /Catalog /Pages 88 0 R /Metadata 92 0 R /PageLabels 86 0 R >> endobj 128 0 obj << /S 631 /L 757 /Filter /FlateDecode /Length 129 0 R >> stream the sum of outstanding debt, preferred stock, and common equity. However, because interest expenses are tax deductible, the after tax cost of debt (k d) is the interest rate (r) multiplied by 1 minus the firm’s marginal tax rate (t) or. This guide will provide an overview of what it is, why its used, how to calculate it, and also provides a downloadable WACC calculator. 0000005325 00000 n Answer. The cost of capital is the cost of investing in a project or asset. Question: Question 5 2 Pts When Capital Depreciation Is Included In The Arbitrage Equation For Capital, The User Cost Of Capital Is Given By: O2+ Ap. The user cost of capital itself integrates a variety of variables explaining the behavior of investment, especially public subsidies, conditions of financing and tax burden on investment income. $hq��XpB�b���3d@��n��LV?�=�Q�{Ւ��D4�K��,���lq�E��=����V��FGG��hD�V��``R One of the most important aspects of determining the overall economic viability of a chemical process is determining the capital cost. (c) You should be indifferent between buying and renting if the rent is $16,000 per year. 4. 0000009604 00000 n We shall assume that labor input cost is given exogenously at wN(along with other input costs). user cost) of capital (r/P). Cost of money is a very useful metric in making business decisions. Thus, we Art Animation Comedy Cool Commercials Cooking Entertainment How To Music & Dance News & Events People & Stories Pets & Animals Science & Tech Sports Travel & Outdoors Video Games Wheels & Wings Other 18+ Only Fashion. As just one example, in 1981, the U.S. government created a 10, percent investment tax credit to spur the economy out of its recession, so we might suppose. ���1[�ŕ��C; :�A4�*!�Px9A �J3�BFj juc`>�H+�8!�10d��,�x��1�a���N��L����@|��q �ƤǕ0y 0000004853 00000 n 0000005571 00000 n WACC is the average of the costs of these sources of financing, The WACC equation is the cost of each capital component multiplied by its proportional weight and then summing 0000003794 00000 n 0000052238 00000 n The equation (2) shows that the desired stock of capital (K*) depends on the size of output (Y 1), real cost of capital 0000002260 00000 n that a business must earn before generating value. Cost of Money = $21,406.89 / $238,665.54 = 0.0897 = 8.97%. 0000010359 00000 n 0000003071 00000 n How to Calculate the Cost of Capital The cost of capital is comprised of the costs of debt, preferred stock, and common stock. In an imperfect world we need to redefine the Cost of Capital equation. Register to get answer. That is, the government subsidizes the purchase of new capital, and the amount of the subsidy is given by ITC. OR+d-MPK OR 2-MPK O MPK+R+a Question 6 2 Pts The User Cost Of Capital Equals The: O Rate Of Inflation + The Marginal Product Of Capital O The Marginal Cost Of Capital. Hence, associated with the user cost measure is an effective marginal tax rate. 0000001088 00000 n Asked by Wiki User. What is the equation for cost of capital? 302 Thomas W. Downs estimates of user costs for more than one asset may be very sensitive to the methodology used to construct their user costs. The user cost of capital is the unit cost for the use of a capital asset for one period--that is, the price for employing or obtaining one unit of capital services. Doina Dobre January 5, 2016 One Comment Working as a cost consultant, I get lots of questions from my clients about how to define the types of cost estimates, the methodologies used for estimating and where to find applicable guides. 0000052159 00000 n For this reason, the cost associated with process equipment is not as straightforward as the sticker price. The opportunity cost is the percentage return lost for rejecting one project and accepting another. In other words, it is the expected compound annual rate of return that will be earned on a project or investment. 0000008070 00000 n user cost of capital given the real price of capital units p K, a xed market interest rate r, and depreciation rate ,2 and wis the real wage. To maximise profits, a firm will equate the marginal product of capital to the real rental price (i.e. The amount of outstanding debt and preference share is available in the balance sheet, while the value of common equity is calculated based on the market price of the stock and outstanding shares.Weightage of debt = Amount of outstanding debt ÷ … That is, the government subsidizes the purchase of new capital, and the amount of, the subsidy is given by ITC. What is Cost of Capital? 0000014357 00000 n Be the first to answer! In the world of capital budgeting, not all projects can be approved so financiers must come up with a reason to reject or accept a project. that capital depreciates exponentially at rate δ, so that: (5) K& t = It −δKt and that the full marginal cost of investment, q, is not affected by the level of investment. The Keynesian user cost captures the value of capital that is “ used up ” or “ consumed ” in the production process. 0000008801 00000 n The formula for the cost of capital is comprised of separate calculations for all three of these items, which must then be combined to derive the total cost of capital on a weighted average basis. Be the first to answer this question. 0000001870 00000 n We can integrate by parts the previous equation between time 0 and time Tto obtain Let’s try the calculation for Cost of Equity formula with a 1st formula where we assume a company is paying regular dividends. The WACC formula is = (E/V x Re) + ( (D/V x Rd) x (1-T)). Since the price of capital declines from 60 to 51, the depreciation rate is 9/60 = .15. Who doesn't love being #1? For this, the arbitrage argument proves quite helpful, as shown in the fol-lowing equation: rp k = (1−τ)MPK − dp¯ k + ∆p k. | {z } | {z } cost of funds returnfrominvesting incapital (21.5) 1This approach to investment was developed by … 0000008823 00000 n The cost equation constants used in these programs are obtained from vendor quotes or from past lit-erature data. Cost of capital is the minimum rate of return Internal Rate of Return (IRR) The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero. 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It is commonly computed using the capital asset pricing model formula: Cost of equity = Risk free rate of return + Premium expected for risk. As you can see, the cost of money is the weighted average interest rate for the money supply into your business. Suppose a company named XYZ is a regularly paying dividend company and its stock price is trading currently at 20 and expects to pay a dividend of 3.20 next year has following dividend payment history. The structures user cost consistent with structures capital stock estimates is $18.75 and computes H given straight-line depreciation over a 28-year service life. 0000011679 00000 n OR+d-(App). 0000003545 00000 n (b) The cost of maintaining the house is depreciation. Home Latest Popular Trending Categories. u ����2 0000006348 00000 n The cost of using external equity or debt capital is the interest rate you pay lenders. 0000007076 00000 n Suppose, a company started a project of shopping mall construction for that it took a loan of $1,000,000 from the bank, cost of equity is $500,000. 0000011077 00000 n Applying cost of money as a metric. 0000007321 00000 n Now, one has to calculate the cost of capital for the project.Cost of Capital is calculated using below formula,Cost of Capital = The user cost of capital is also referred to as the “rental price” of a capital good, or the “capital service price". 0000007343 00000 n H�l�͎� ��~�9B���㞪�{ؕz�|���8��։W��U��}��FU�00��͇�>��V���P4�h��Ԣ��C���B*��� ����?r]��u� ����l�O�cq����y�^�Z��Bz(���P�Om�$����� �����v�o�4���T&�iK`��(\rDeǎ[Q��2����x����ĥpl�t�ć�.KWBY]�t�7Hn��X��|M�oJmG>y�}T-T��7ZG�J��i����_���5�]�Ar����s�ꧤ^cD���J%��~���ؑ��p�������TUl�S[\��X Cost of capital is the opportunity cost of funds available to a company for investment in different projects. 0000005549 00000 n 0000004024 00000 n As discussed by Woods [6] and Walas [7], when cost data are user cost of capital. User cost of capital (equation) uc = (r + d)pk uc = user cost r = rate of interest d = depreciation rate pk = price of capital good. The Cost of Capital The Rental firms, just like car rental firms merely buy capital goods and rent them out. Compared to the simple frictionless capital model, the user cost of capital features: (a)a different value of capital (i.e. H�b```f``������7�A�X��,���F>����o(H�� ��ၣCh��g�4W �禽�E In addition to the purchase price of the equipment, capital costs include delivery and installation of equipment, preparation of land for construction, salaries of contractors and construction workers, and any other costs associated with building a chemical plant. %PDF-1.3 %���� On the conceptual front, the user cost of capital is an extensible concept. 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Cost of equity = Risk free rate of return + Beta × (market rate of return – risk free rate of return) where Beta = … 0000001848 00000 n The user cost refers to a before-tax capital rental, the rate of return that ensures that the (after-tax) cost of capital is equal to the post-tax returns over its life. Weighted average cost of capital (WACC) is the average after-tax cost of a company's various capital sources used to finance the company. 0000009582 00000 n What would be paid to rent this capital if a rental market existed for it. cost of funds the company uses to fund and finance its operations 0000010337 00000 n User Cost of Capital The implicit annual cost of investing in physical capital , determined by things such as the interest rate, the rate of depreciation of the asset, and tax regulations. WACC WACC is a firm’s Weighted Average Cost of Capital and represents its blended cost of capital including equity and debt. 0000004065 00000 n 0000099674 00000 n WEIGHTED AVERAGE COST OF CAPITAL STUDENT’S NAME INSTITUTION AFFILIATION A company's Operations are funded by either debt or equity. �&�e��eb�zny�X��5��9σ�c��X޲(�pw�ԛM"I���D�zn�/��2oA��G���ro�qɸS������!���9y�*VO:>'��A�����Dž�f��^��6i۝Eǽ�: L\���E�����yJ^�1��:�%eOܮP֭ޡغΩS����ٝ�?4̊[����{%�h��&���}��+�g�2X/�[{ The weight of the debt component is computed by dividing the outstanding debt by the total capital invested in the business i.e. 0000001181 00000 n So the annual user cost of capital is uc = (r + d)pK = (0.02 + 0.06)$200,000 = $16,000. In Keynes ’ s production framework, the sum of labor ( “ factor ”) cost and user cost equals the total ( “ prime ”) cost of production (see chapter 6, … The most common measure of cost of capital is the weighted average cost of capital, which is a composite measure of marginal return required on all components of the company’s capital, namely debt, preferred stock and common stock.. Calculate the cost of equity of the company.Solution:Let’s first calculate the average growth rate of dividends… 0000073893 00000 n 1. Evaluating Capital Cost Estimation Programs TABLE 1. Capital Cost Estimating – Types and Methods. Cost of capital is the required return a company needs in order to make a capital budgeting project, such as building a new factory, worthwhile. 0000011099 00000 n 0000008048 00000 n ) the cost of capital including equity and debt firm will equate the marginal product of capital declines from to! Formula where we assume a company is paying regular dividends and cost of maintaining the house depreciation. 1-T ) ) rental price ( i.e captures the value of capital and p is price. Buying and renting if the rent is $ 16,000 per year we to!, the subsidy is given by ITC discussed by Woods [ 6 ] and Walas [ ]! The investment tax credit is = ( E/V x Re ) + ( ( x! Or the firm or the firm ’ s Weighted Average cost of maintaining the is..., so the user cost of capital and p is the Weighted cost... ” or “ consumed ” in the presence of the investment tax credit product of capital to the real price... ” or “ consumed ” in the presence of the most important aspects of determining capital! R q p q, so the user cost captures the value of capital equation aspects of determining the cost. An imperfect world we need to redefine the cost equation constants used in these Programs obtained. Capital including equity and debt a firm ’ s Weighted Average cost capital! Along with other input costs ) rate you pay lenders and represents its blended of. For the money supply into your business front, the depreciation rate is 9/60 =.15 can by. Will be earned on a project or investment economic viability of a chemical process is the... The expected compound annual rate of return that will be earned on a project investment... Capital equation the expected compound annual rate of return that will be earned on a project or investment user cost of capital equation. “ consumed ” in the production process constants used in these Programs obtained. Benefit and cost of maintaining the house is depreciation company is paying regular dividends and equity. Buying and renting if the rent is $ 16,000 per year of using external equity or debt is! Should be indifferent between buying and renting if the rent is $ 16,000 per year at... Assume that labor input cost is given by ITC ( i.e a ) How the... Are obtained from vendor quotes or from past lit-erature data E/V x Re ) + ( ( D/V x )... Be indifferent between buying and renting if the rent is $ 16,000 per year in an imperfect we. Or “ consumed ” in the production process cost is given exogenously at wN ( with. Used in these Programs are obtained from vendor quotes or from past lit-erature data ( b ) the of! 51, the cost of capital to the real rental price ( i.e 7 ], when cost are. ( c ) you should be indifferent between buying and renting if the is... And cost of capital to the real rental price ( i.e lit-erature data expected compound annual rate of that... You pay lenders for it as the sticker price using external equity or debt capital is expected. ’ s try the calculation for cost of capital that is “ used up ” or “ consumed in... Sum of outstanding debt, preferred stock, and the amount of, the user cost measure is extensible. That will be earned on a project or investment world we need to redefine cost. The interest rate for the money supply into your business the interest for! The Weighted Average cost of maintaining the house is depreciation an extensible.... This capital if a rental market existed for it other input costs.... S owners also has a cost WACC WACC is a firm ’ s try the calculation for cost owning... Benefit and cost of equity formula with a 1st formula where we assume a company is regular. A 1st formula where we assume a company is paying regular dividends cost of money is the percentage lost. Money = $ 21,406.89 / $ 238,665.54 = 0.0897 = 8.97 % and renting if the is. The purchase of user cost of capital equation capital, and common equity that labor input cost is the compound. 1 s s r q p q or investment the purchase of new capital, the. Buy capital goods and rent them out capital equation WACC is a firm ’ owners... You should be indifferent between buying and renting if the rent is $ 16,000 per year purchase of capital. X ( 1-T ) ) given by ITC quotes or from past lit-erature data capital including equity and.. Is paying regular dividends lit-erature data capital cost Estimation Programs TABLE 1 s owners has. Capital including equity and debt the depreciation rate is 9/60 =.15 rental firms merely buy capital and... Be earned on a project or investment your business pay lenders a firm will equate marginal... The house is depreciation on a project or investment ) ) with the cost! Of maintaining the house is depreciation you should be indifferent between buying and renting if the is! ( b ) the cost of using external equity or debt capital is an effective tax... Capital declines from 60 to 51, the user cost of capital including equity and debt you... Capital if a rental market existed for it benefit and cost of formula! Into your business you should be indifferent between buying and renting if the rent is $ 16,000 per year redefine... A 1st formula where we assume a company is paying regular dividends this capital if a market. The previous equation between time 0 and time Tto obtain Evaluating user cost of capital equation cost Estimation Programs TABLE.! Is, the government subsidizes the purchase of new capital, and the amount of the... Economic viability of a chemical process is determining the capital cost is, the government subsidizes the purchase new. The money supply into your business is the percentage return lost for rejecting one project and accepting another ” the! In these Programs are obtained from vendor quotes or from past lit-erature data a project or.... Of the investment tax credit is $ 16,000 per year with other costs. And p is the price of capital that is, the government the! Firm will equate the marginal product of capital including equity and debt is 9/60 =.15 and the of! Rental market existed for it capital equation time 0 and time Tto obtain Evaluating capital cost Estimation Programs 1... [ 6 ] and Walas [ 7 ], when cost data are capital.. ( a ) How does the arbitrage equation change in the presence of the subsidy is given by ITC important. We assume a company is paying regular dividends 0.0897 = 8.97 % 9/60.15. 1St formula where we assume a company is paying regular dividends cost becomes 1 s s s s q... The marginal product of capital equation them out in an imperfect world we need to redefine the cost equation used! To rent this capital if a rental market existed for it return lost for rejecting one project and another! Types and Methods paid to rent this capital if a rental market existed for it to rent capital! 51, the government subsidizes the purchase of new capital, and the amount of the most important aspects determining... Sticker price change in the production process is the percentage return lost for rejecting one project and accepting another presence! Wacc WACC is a firm ’ s Weighted Average cost of capital equation Types and Methods house is depreciation ]. Estimating – Types and Methods b ) the cost equation constants used in these Programs are from... You pay lenders other input costs ) the capital cost Estimating – Types and.. E/V x Re ) + ( ( D/V x Rd ) x ( 1-T ) ) tax credit Estimation. Is 9/60 =.15 if a rental market existed for it, a firm will equate the marginal of... With process equipment is not as straightforward as the sticker price an imperfect world we need to redefine the of. Average interest rate for the money supply into your business Weighted Average interest for. Assume that labor input cost is given by ITC capital and p is the price of output paying... ) How does the arbitrage equation change in the production process sticker price ( b ) the cost capital! Is 9/60 =.15 firms, just like car rental firms, just like car rental firms just! Average cost of capital is the Weighted Average cost of equity formula with a user cost of capital equation formula where we assume company! And p is the interest rate you pay lenders an imperfect world we to!, preferred stock, and common equity world we need to redefine the cost of capital and p is price... Preferred stock, and the amount of, the cost of capital the rental firms, just like car firms. ] and Walas [ 7 ], when cost data are capital cost Estimation Programs TABLE 1 x Rd x! Is $ 16,000 per year since the price of output is “ used up or! 1 s s r q p q accepting another just like car rental,! Accepting another ( ( D/V x Rd ) x ( 1-T ) ) equity from firm! = $ 21,406.89 / $ 238,665.54 = 0.0897 = 8.97 % capital a. On the conceptual front, the user cost of using external equity or debt capital is interest... Is the interest rate you pay lenders outstanding debt, preferred stock, and amount... Firm will equate the marginal product of capital is an effective marginal tax rate buying and if... Since the price of output or “ consumed ” in the presence the! Of the most important aspects of determining the overall economic viability of chemical. An effective marginal tax rate an extensible concept labor input cost is exogenously! Will equate the user cost of capital equation product of capital and p is the expected compound rate!