# A firm’s current profits are \$850,000. These profits are expected to grow indefinitely at a constant

June 3, 2016

Question
HW1 Managerial Economics –

1) A firm’s current profits are \$850,000. These profits are expected to grow indefinitely at a constant annual rate of 5 percent. If the firm’s opportunity cost of funds is 8 percent, determine the value of the firm:

Instructions: Round your responses to 2 decimal places.

a. The instant before it pays out current profits as dividends.

\$
million

b. The instant after it pays out current profits as dividends.

\$
million

2)

Suppose the total benefit derived from a given decision, Q, is B(Q) = 20Q – 2Q2 and the corresponding total cost is C(Q) = 4 + 2Q2, so that MB(Q) = 20 – 4Q and MC(Q) = 4Q.

Instruction: Use a negative sign (-) where appropriate.

a. What is total benefit when Q = 2? Q = 10?

When Q = 2:

When Q = 10:

b. What is marginal benefit when Q = 2? Q = 10?

When Q = 2:

When Q = 10:

c. What level of Q maximizes total benefit?

d. What is total cost when Q = 2? Q = 10?

When Q = 2:

When Q = 10:

e. What is marginal cost when Q = 2? Q = 10?

When Q = 2:

When Q = 10:

f. What level of Q minimizes total cost?

g. What level of Q maximizes net benefits?

3) Jaynet spends \$50,000 per year on painting supplies and storage space. She recently received two job offers from a famous marketing firm – one offer was for \$85,000 per year, and the other was for \$115,000. However, she turned both jobs down to continue a painting career. If Jaynet sells 35 paintings per year at a price of \$6,000 each:

a. What are her accounting profits?

\$

b. What are her economic profits?

\$

4)

Jamie is considering leaving her current job, which pays \$75,000 per year, to start a new company that develops applications for smart phones. Based on market research, she can sell about 50,000 units during the first year at a price of \$4 per unit. With annual overhead costs and operating expenses amounting to \$145,000, Jamie expects a profit margin of 20 percent. This margin is 5 percent larger than that of her largest competitor, Apps, Inc.

a. If Jamie decides to embark on her new venture, what will her accounting costs be during the first year of operation? Her implicit costs? Her opportunity costs?

Accounting costs: \$

Implicit costs: \$

Opportunity costs: \$

b. Suppose that Jamie’s estimated selling price is lower than originally projected during the first year. How much revenue would she need in order to earn positive accounting profits? Positive economic profits?

Revenue needed to earn positive accounting profits: \$

Revenue needed to earn positive economic profits: \$

5) Approximately 14 million Americans are addicted to drugs and alcohol. The federal government estimates that these addicts cost the U.S. economy \$300 billion in medical expenses and lost productivity. Despite the enormous potential market, many biotech companies have shied away from funding research and development (R&D) initiatives to find a cure for drug and alcohol addiction. Your firm – Drug Abuse Sciences (DAS) – is a notable exception. It has spent \$200 million to date working on a cure, but is now at a crossroads. It can either abandon its program or invest another \$60 million today. Unfortunately, the firm’s opportunity cost of funds is 5 percent and it will take another five years before final approval from the Federal Drug Administration is achieved and the product is actually sold. Expected (year-end) profits from selling the drug are presented in the accompanying table.

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9

\$0

\$0

\$0

\$0

\$12,000,000

\$13,400,000

\$17,200,000

\$20,700,000

\$22,450,000

What is the net present value of the project?

Instruction: Round your answer to the nearest penny (2 decimal places). Use a negative sign (-) where appropriate.

\$