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Chapter 1

Chapter 1 answers

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Economics 2163A/B

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Chapter 1: Answers to Questions and Problems 3. a. Net benefits areQ 50 20Q 5Q .2 b. Net benefits wheQ 1are N 1 50 20 5 65 and when Q 5 they are 2 N 5 50 20 5 5 5 25 . c. Marginal net benefits MNB Q 20 10Q . d. Marginal net benefits whQn 1 areMNB 1 20 10 1 10 and when Q 5 they are MNB 5 20 10 5 30 . e. SettingMNB Q 20 10Q 0 and solving foQ , we see that net benefits are maximized when Q 2 . f. When net benefits are maximized Qt 2 , marginal net benefits are zero. That is, MNB 2 20 10 2 0 . 12. Effectively, this question boils down to the question of whether it is a good investment to spend an extra $100 on a refrigerator that will save you $25 at the end of each year for five years. The net present value of this investment is $25 $25 $25 $25 $25 NPV $100 1.05 1.05 2 1.05 3 1.05 4 1.05 5 $108.24 $100 $8.24. You should buy the energy efficient model, since doing so saves you $8.24 in present value terms. 14. a. Accounting costs equal $3,160,000 per year in overhead and operating expenses. Her implicit cost is the $56,000 salary that must be given up to start the new business. Her opportunity cost includes both implicit and explicit costs: $3,160,000 + $56,000 = $3,216,000. b. To earn positive accounting profits, the revenues per year should greater than $3,160,000. To earn positive economic profits, the revenues per year must be greater than $3,216,000. 15. First, note that the $170 million spent to date is irrelevant, as it will be lost regardless of the decision. The relevant question is whether the incremental benefits (the present value of the profits generated fromthe drug) exceed the incremental costs (the $30 million needed to keep the project alive). Since these costs and benefits span time, it is appropriate to compute the net present value. Here, the net present value of DAS’s R&D initiative is 15,000,00016,500,000 18,150,00019,965,000 21,961,500 NPV (1 0.07)5 (1 0.07)6 (1 0.07)7 (1 0.07)8 (1 0.07) 9 30,000,000 $26,557,759.86. Since this is positive, DAS should spend the $30 million. Doing so adds about $26.6 million to the firm’s value. 16. Disagree. In particular, the optimal strategy is the high advertising strategy. To see this, note that the present value of the profits from each advertising strategy are as follows: Managerial Economics and Business Strategy, 7e
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