03 Jun Question 1. Consider the following two projects
Question
1. Consider the following two projects
Project A: Costs $12,000 today. Increases profit by $3000 next year, $7,200 in
two years, and $4000 in three years.
Project B: Costs $7500 today. Increases profit in two years by $8190
Both projects have no value beyond the given time frames. A firm faces a rate to
borrow money of 9% and has the option of investing money with almost no risk at
5%.
a) If the firm has $25,000 on hand, with only these two project to choose from,
will they invest in A, B, neither or both? Show the calculations that lead to your
conclusions. Explain whether you answers would be different for either project if
the firm had no money on hand to invest. (1 point)
b) Explain, based on your calculations in (a), why the rate of return on project A
must be somewhere between 5% and 9%. Set up (but do not solve) and
equation that would find the rate of interest where the firm is indifferent between
investing in project A, and not investing in project A. (1 point)
d) Use the data in (a) to bound the rate of return for project B, then use an
equation like the one in (b) to actually find the rate of return of project B. Verify
that it is consistent with the bound you found. (2 points)
2. An economy is currently made up of a firm that produces bread, a firm that
produces butter, and a consumer who consumes both bread and butter. Current
production is 100 units of bread, 50 units of butter which the consumed by the
consumer. If the output changed to 75 units of bread and 60 units of butter, the
profit of the butter firm would go up by $42. The profit of the bread firm would go
down by $76. The consumer prefers 75 bread and 60 butter to 100 bread and 50
butter. It is so much better that the consumer would pay $40 more to have 75
bread and 60 butter rather than have 100 bread and 50 butter. Explain, using the
definition, why you know it is not Pareto Efficient to have the economy produce
100 bread and 50 butter. (1 point)
3. A demand curve is given by the following equation: P = -4Q + 160.
i) Calculate the Total Revenue when Q = 25 and when Q = 28.
ii) Calculate the price elasticity of demand between Q = 25 and Q = 28.
Round decimal answers to two places.
Explain why the relation between the numbers in (i) and (ii) makes sense. (1
points
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