You are considering installing all new compact fluorescent light bulbs in your h

Question

You are considering installing all new compact fluorescent light bulbs in your house. Your initial investment in the light bulbs will cost a total of $400 and you expect them to last 4 years. At the end of each year, you will have saved $125 in electricity costs (assume that you pay your electricity bill only one time per year, at the end of the year). If you don't install the bulbs, you would invest your money and expect to earn 5% per year. Show all your work for the following questions. Calculate the future value of the next best alternative (e.g. investing the money at 5%) Should you buy and install the light bulbs? Why or why not?

Explanation / Answer

a. Future value of 400 = PV*(1+i)^n = 400*(1+0.05)^4

  Future value of 400 = 400*1.215 = 486.20

b. Benefit from installing = 125*(1+0.05)^3 + 125*(1+0.05)^2 + 125*(1+0.05) + 125

= 538.7656

So, Benefit from buying and Installing the light bulbs is more than the benefits from other/best alternative option.

Hence , he should install the light bulb.

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