Suppose that at an initial cost of $1000, a homeowner can insulate his house and save $50 each year in heating bills. What is the highest interest rate at which the homeowner should insulate? What equation would you use to find this? Is the interest rate per year or what?
There are two ways to approach this problem. For simplicity, in both of them I will assume that the $50 savings is realized at the end of each year, and that you're considering insulating the house at the beginning of the year.
The simple approach: the insulation costs $1000 and saves you $50 per year. This is equivalent to investing $1,000 in a bank and collecting a $50 interest per year. Since $50 is 5% of $1,000, insulating the home is an investment that returns 5% per year.
Now, if the market interest rate ...
Examine the market interest rate and other facets.