A firm is considering the purchase of a capital good that will generate an additional $40,000 income each year for 4 years (after which time the capital good is useless and has no scrap value). The interest rate is 4 percent. It follows that the firm should not purchase the capital good if its price is greater than (approximately)

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To determine whether the firm should purchase the capital good, we calculate the present value of the income it generates over 4 years at a 4% interest rate. Using the formula for the present value of an annuity: PV = P * [(1 - (1 + r)^-n) / r], where P = $40,000, r = 0.04, and n = 4, we find the present value to be approximately $111,004. If the price of the capital good exceeds this value, the firm should not purchase it.

A Firm Is Considering the Purchase of a Capital Good