Questions set

Q1

A publisher is deciding whether or not to invest in a new printer. The printer would cost $900, and would increase the net cash flows in year 1 by $500 and in year 3 by $800. Cash flows are $0 in Year 2.  If the interest/discount rate is 12%

 

a.       What is the net present value of the investment?  –

b.      Should the publisher invest in the new printer?  Explain why,

​    c.      If the interest/discount rate rises to 25%, what would happen to NPV?  Should the investment still take place? Explain why.

d.       If net cash flows change such that the investment renders a cash flow of $500 in year 1 and $800 in year 2 instead of year 3, what would happen to NPV?  Would the investment still take place with a 25% interest rate?

Q2

A local restauranteur owns a profitable restaurant and then decides to purchase a liquor license giving her the right to sell beer, wine and spirits for $90,000.  While the license is transferable, only $75,000 is refundable if the owner chooses not to use the license at any future time.  After selling alcoholic beverages for a year, the owner realizes that she was losing dinner customers and her once profitable restaurant was turning into a noisy, unprofitable bar.  Subsequently, she spent $8,000 placing advertisements in various newspapers and restaurant magazines offering to sell the license for $80,000.

1. What is the local restauranteur’s sunk costs? Explain.

2. Using only the information above, was her decision to spend $8,000 on advertising to sell the license a wise one? Why?

After a long wait, she finally received an offer to purchase her license for $77,000.

3.  Would you recommend that she accept the $77,000 offer? Why?

Q3

Cobb Company incurs costs of $18 in variable costs and $10 in fixed costs to make a product that normally sells for $42. A foreign wholesaler offers to buy 5,000 units at $25 each. Cobb will incur additional shipping costs of $1 per unit.  Assuming Cobb has excess operating capacity, should Cobb Company accept the special order? Explain why.

 

4 Sonya quit her $30,000-a-year job as a postal employee and opened a skeet shooting range on her land. She takes $100,000 out of her brokerage account, which was earning 10% a year on average, to invest in the skeet shooting range. The range generates $100,000 in revenues each year.  She spends $40,000 a year in employee salaries, $20,000 a year in ammunition and supplies for the skeet shooting, and $10,000 in office supplies.

a.       What is Sonya’s accounting or business profit? Explain.

b.       What is Sonya’s economic profit? Explain.

c.     Assuming that Sonya is indifferent between working as a postal employee and owning a skeet shooting range, should Sonya continue owning the skeet shooting range? Why?

Q5

American Automobile Association (AAA)  states that it costs on average 73 cents per mile to drive a car 10,000 miles per year.  The AAA includes the following costs in its calculation:  fuel, maintenance, repair and tires, insurance, license and registration fees, depreciation and interest on car loans.

Your employer wants you to attend a conference for work.   You plan to attend the conference whether you drive your own car or not. Your employer offers you 52 cents a mile if you drive your own car. Will it pay for you to drive, or should you say no and hitch a ride with someone else? Explain how you would make that decision in a few sentences

Q6

Assume that you have been waiting in line for one hour at the Department of Motor Vehicles to renew your license. You comment to the person next to you that you really have some important things to do and you are seriously thinking of getting out of the line and returning to renew your license tomorrow. The person responds by telling you that you are making a big mistake since the time that you have spent waiting in line is an investment and that you should not waste it. Evaluate critically this person’s response

 

Q7

Why do people spend more time and effort deciding on what car to buy than they do choosing a brand of toothpaste?