Chapter 1

 

1.  You are the manager of a Fortune 500 hotel chain and must decide where to locate a

     new hotel. Based on tax considerations, your accounting department suggests that

     Atlantic City is the best choice, followed closely by Las Vegas. In particular, your

     current year tax savings from locating in Atlantic City are $4 million but only $3

     million in Las Vegas. Your marketing department, on the other hand, has provided

     you with sales estimates that suggest that the present value of the gross (of tax)

     operating profits from locating in Atlantic City are only $10 million but are $14

     million for Las Vegas. It will cost $14 million to build the hotel in either location.

     Ignoring all other considerations, where should you build the hotel? What are your 

     firm’s economic profits if you locate the hotel in Atlantic City?

 

 

2.  You have just been hired as a consultant to help a firm to decide which of three

         options to take to maximize the value of the firm over the next three years. The

         following table shows year-end profits for each option. Interest rates are expected

         to be stable at 8 percent over the next three years.

 

Option

Profits in Year 1

Profits in Year 2

Profits in Year 3

A

$70,000

$80,000

$90,000

B

$50,000

$90,000

$100,000

C

$30,000

$100,000

$115,000

 

         Which option has the greatest present value?

 

3.   A potential entrepreneur is trying to decide whether to open a new health spa. She

      presently makes $35,000 per year as an aerobics instructor and will have to give up

      this job if she opens the new spa. If she chooses to open the spa, it will cost her

      $200,000 per year in rent and other operating expenses.

     a.  What are her accounting costs?

  1. What are her opportunity costs?
  2. How much would she need to make in revenues to earn positive accounting profits? Positive economic profits?

 

4.  You are the manager of a firm that specializes in selling exotic animals to zoos around

      the world. Your goal is to determine the number of baby zebras (Z) that must be born

      on your firm’s farms each month in order to maximize profits. The total benefits

      (revenues) and costs to your firm of producing various quantities of zebras is given in

      the first three columns of the table below. Based on this scenario, complete the table

      and answer the accompanying questions;

 

 

 

 

 

(1)

 Control Variable

 Z

(2)

Total Benefits B(Z)

(3)

Total Costs C(Z)

(4)

Net Benefits N(Z)

(5)

Marginal Benefit

MB(Z)

(6)

Marginal Cost

MC(Z)

(7)

Marginal Net Benefit

MNB(Z)

0

0

0

 

-

-

-

1

200

10

 

 

 

 

2

380

30

 

 

 

 

3

540

60

 

 

 

 

4

680

100

 

 

 

 

5

800

150

 

 

 

 

6

900

210

 

 

 

 

7

980

280

 

 

 

 

8

1040

360

 

 

 

 

9

1080

450

 

 

 

 

10

1100

550

 

 

 

 

 

  1. What level of zebra births maximizes net benefits?
  2. What is the relation between marginal benefit and marginal cost at this level of Z?
  3. Graph the total cost and total benefit curves.
  4. On another graph, plot the points for the marginal cost, marginal benefit, and marginal net benefit.
  5. Show how the two graphs relate to each other.

 

5.  Your firm’s research department has estimated your total revenues to be

      R (Q) = 3,000Q-8Q2 and your total costs to be C (Q) = 100 + 2Q2.

            (Note that MB=3,000-16Q and MC = 4Q.)

  1. What level of Q maximizes net benefits?
  2. What is the marginal benefit at this level of Q?
  3. What is marginal cost at this level of Q?
  4. What is the maximum level of net benefits?
  5. What is another word for net benefits in this example?

 

 

6. Delta Software earned $10million this year. Suppose the growth rate of Delta’s                   

    profits and interest rate are both constant and Delta will be in business forever.

    Determine the value of Delta Software when

a.    The interest rate is 10% and profits grow by 4% per year.

b.   The interest rate is 10% and profits grow by 0 % per year.

c.    The interest rate is 10% and profits decline by 4% per year.

 

7. You are a strong advocate for a one-year investment project that would cost your firm $10,000 today, but generate virtually certain earnings of $15,000 at year-end. Those in your firm’s financial group concur that the investment is virtually risk-free, but nonetheless your boss is concerned about the firm’s cash flow problems. Suppose that the going rate of interest is 20%. Convince your boss to undertake the project.

 

8. Individuals who choose to attend school have made a decision to invest in human        

capital. Use the terminology of net present value analysis to explain why you are attending school.