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#### Texas A&M International University ECO 3320 CHAPTER 5 1)The lower the interest rates the more value individuals place on future dollars the less value individuals place on future dollars less investments will take place does not affect the investment strategy   According to the Net Present Value (NPV) rule, managers choose to invest if The NPV of the project is less than zero The NPV of the project is greater than zero The NPV of the project is equal to zero The NPV of the project is equal to the cost of capital   In the short-run, a firm’s decision to shut-down should not include Avoidable costs Variable costs Fixed costs Marginal costs   Use the following information to answer the next two questions:   A publisher is deciding whether to invest in a new printer that needs an initial investment of \$500

###### Economics

Texas A&M International University

ECO 3320

CHAPTER 5

1)The lower the interest rates

1. the more value individuals place on future dollars
2. the less value individuals place on future dollars
3. less investments will take place
4. does not affect the investment strategy

1. According to the Net Present Value (NPV) rule, managers choose to invest if
1. The NPV of the project is less than zero
2. The NPV of the project is greater than zero
3. The NPV of the project is equal to zero
4. The NPV of the project is equal to the cost of capital

1. In the short-run, a firm’s decision to shut-down should not include
1. Avoidable costs
2. Variable costs
3. Fixed costs
4. Marginal costs

Use the following information to answer the next two questions:

A publisher is deciding whether to invest in a new printer that needs an initial investment of

\$500. This will increase cash flows in the first year by \$600 for the next two years.

1. If the interest rate is 10% then the net present value of these cash flows is a) \$1041.32

b) \$541.32

c) \$1090.91

d) \$590.91

1. If the cost of capital increased to 25%, does the firm invest in the printer?
1. Yes because the NPV>0
2. Yes because the NPV=0
3. Need information on the marginal benefits and costs
4. No because the NPV<0

Use the following information to answer the next two questions:

A firm’s fixed costs are \$5000. The firm charges \$12 for each unit. For every additional unit the firm produces, it costs the firm \$8.

1. What’s the firm’s contribution margin?

a)   \$12

b)   \$10

1. \$8
2. \$4

1. The break-even quantity is a) 1250

b) 625

c) 416.67

d) 500

1. A firm sells1000 units per week. It charges \$15 per unit, the average variable costs are \$10, and the average costs are \$25. The firm should
1. Shut-down as the firm is making a loss of \$10,000 per week
2. Shut-down as the firm cannot cover the fixed costs
3. Continue operating as the firm is covering all the variable costs and some of the fixed costs
4. Shut-down because it is cost effective to pay off the remaining fixed costs

1. Based on the above information, at what price does the firm consider shutting-down?

a) \$25

1. \$0

c) \$15

d) \$10

1. What are some of the solutions for a hold-up problem?
1. Mergers

1. Contracts
2. Exchange of ‘hostages’
3. All the above

1. The higher the interest rates
1. the more value individuals place on future dollars
2. the more value individuals place on current dollars
3. less investments will take place
4. does not affect the investment strategy

Use the following information to answer the next two questions:

A manufacturing firm is deciding whether to invest in a new printer that needs an initial investment of \$150,000. This will increase cash flows in the first year by \$80,000 and

\$75,000 in the second year.

1. If the interest rate is 10% then the net present value of these cash flows is a) \$5,000

b) - \$9,091

c) -\$15,290

d) -\$21,901

1. If the cost of capital decreased to 1%, does the firm invest in the new technology?
1. Yes because the NPV>0
2. Yes because the NPV=0
3. Need information on the marginal benefits and costs
4. No because the NPV<0

1. A firm sells 300,000 units per week. It charges \$ 35 per unit, the average variable costs are \$ 40, and the average costs are \$ 55, the firm should
1. Shut-down as the firm is making a loss of \$15 million per week
2. Shut-down as the firm cannot cover the variable costs
3. Both a and b
4. None of the above

1. Based on the above information, at what price does the firm consider shutting-down?

a) \$45

b) \$ 40

c) \$95

d) \$85

Use the following information to answer the next two questions:

A firm’s fixed costs are \$10 million. The firm charges \$1800 for each unit and the firm’s marginal costs are \$1,000.

1. What’s the firm’s contribution margin?

a) \$1800

b) \$800

c) \$1000

d) \$300

1. The break-even quantity is a) 10000

b) 5,555

c) 12,500

d) 5,000

1. A firm will shut down in the short-run if
1. P>AVC
2. P<AVC
3. Profits<0
4. P<ATC

1. A firm will shut down in the long-run if
1. P>AVC
2. P<ATC
3. P=ATC
4. P>ATC

1. Assume a firm has the following cost and revenue characteristics at its current level of output: price=\$10.00, average variable cost=\$8.00 and average fixed cost =\$4.00. This firm is
1. incurring a loss of \$2.00 per unit and should shut down.
2. realizing only a normal profit.
3. realizing an economic profit of \$2.00 per unit.
4. incurring a loss per unit of \$2.00, but should continue to operate in the short run.

1. Assume a firm has the following cost and revenue characteristics at its current level of output: price=\$8.00, average variable cost=\$6.00 and average fixed cost =\$4.00. In the long run, the firm
1. Should shut-down as its making a loss of \$2
2. Should continue operating as long as it is covering the variable costs of \$6
3. Should continue operating as long as it is covering the fixed costs of \$4
4. Should not shut down

1. In order to continue its operations, in the long-run a firm must
1. Charge a price that is equal to its AVC
2. Charge a price that is equal to its AFC
3. Charge a price that is equal to its AVC + AFC

1. The break-even quantity is
1. Fixed Costs/Price
2. Fixed Costs/Marginal Cost
3. Fixed Costs/(Price – Marginal Costs)

1. Contribution Margin/Fixed Costs

1. A business produces 5,000 units per month. Costs include: \$12,000 on raw materials, \$20,000 on operators and \$14,000 on sales people. Other costs of running the factory were \$50,000 for rent and \$30,000 on other fixed overheads. In order to break even the selling price per unit will have to be:

a)   \$25.20

b)   \$29.60

c)   \$20.30

d) \$28

1. A business produces 4,000 units per month which he sells at \$20/unit. Costs include: \$10,000 on raw materials, \$15,000 on operators and \$10,000 on sales people. In order to break even the fixed costs will have to be:

a)   \$35,000

b)   \$40,000

c)   \$45,000

d) \$50,000

1. Break-even quantity is a point where
1. Level of profit is maximized
2. Level of cost is minimized
3. Only variable costs are covered
4. There is neither a profit nor a loss

1. If a firm sells more than the break-even quantity,
1. It will make a profit
2. It will only cover the variable costs
3. It will make a loss
4. A firm is unable to sell above the break-even quantity

1. Which of the following variables is not needed to determine the break-even quantity?
1. Marginal costs
2. Fixed Costs
3. Selling Price
4. Average Costs

1. Which of the following is classified as a sunk cost?
1. Cost of the next best alternative
3. Research costs to determine the implementation of a technology
4. Total cost of producing a product

1. Which of the following will increase the break-even quantity?
1. A decrease in overall fixed costs
2. A decrease in the marginal costs
3. A decrease in the price level

1. An increase in price level
1. Consider a firm that produces 500,000 units per year. The firm’s fixed costs are \$100,000, marginal costs are \$250 and the price per unit is \$400. In the short-run, how low can price go before it is profitable to shut down?

a)   \$150

b)   \$250

c) \$250.20

d) \$400

1. Consider a firm that produces 500,000 units per year. The firm’s fixed costs are \$100,000, marginal costs are \$250 and the price per unit is \$400. In the long-run, how low can price go before it is profitable to shut down?

a)   \$150

b)   \$250

c) \$250.20

d) \$400

Use the following information to answer Questions 33 - 35

Sarah’s Machinery Company is deciding to dump their current technology A for a new technology B with small fixed costs but big marginal costs. The current technology has fixed costs of \$500 and marginal costs of \$50 whereas the new technology has fixed costs of \$250 and marginal costs of \$100.

1. At what quantity is Sarah Machinery indifferent between two technologies?
1. 5
2. 6
3. 7
4. 8

1. What is the total cost at the break-even quantity calculated above?

a)   \$750

b)   \$850

c)   \$950

d) \$1050

1. If the company plans to produce 9 machines, which technology should the firm choose?
1. The low-marginal-cost technology
2. The high-marginal-cost technology
3. Either technology because they are equally cost efficient

1. If the annual interest rate is 0%, the net present value of receiving \$550 in the next year is:

a) \$550

b) \$551.

c) \$549

d) \$500

1. If the annual interest rate is 5%, the net present value of receiving \$550 in the next year is:

a) \$550

b)   \$523.80

c)   \$577.50

d) \$500

1. If the interest rate is 11%, \$1500 received at the end of 12 years is worth how much today? a)   500*(1+.11)12

b) 500/(1 + .11)12

c)   500/(1 + 11)12.

d) 500

Use the following information to answer Questions 39 - 43

Jim’s Production is planning on acquiring a competitive firm with a view to change production technologies. The two firm technologies produce the same output but with different cost functions. Jim’s Production technology has a cost function = 1000 + 0.10Q whereas the competitor‘s cost function = 500 + 0.15Q.

1. Which firm has higher fixed costs?
1. Jim’s Production
2. Competitor
3. They both have the same fixed costs

1. Which firm has higher marginal costs?
1. Jim’s Production
2. Competitor’s production
3. They both have the same fixed costs

1. At what quantity is Jim’s Production indifferent between two technologies? a) 5000

b) 7500

c) 10000

d) 12500

1. What is the total cost at the break-even quantity calculated above?

a) \$750

b)   \$1000

c)   \$1500

d) \$2000

1. If the company plans to produce 5000 units of output, is acquiring the competitor’s technology a good idea?
1. Yes, because the competitor has a low-marginal-cost technology
2. Yes, because the competitor has a high-marginal-cost technology
3. Yes, because the company plans to produce less than the break-even quantity
4. Both b and c

1. If firms anticipate that they are at risk of being held up, firms are more likely to adopt contracts or organizational forms such as
1. investments in reputation
2. mergers
3. exchange of “hostages”
4. All the above

1. Firms that anticipate hold-up, choose organizational or contractual forms
1. To give each party both the incentive to make relationship-specific investments
2. To give each party both the incentive to ignore sunk costs
3. To give each party both the incentive to reduce investments in reputation
4. To give each party both the incentive to make non-specific investments

1. Hold-up can only occur if
1. Costs are fixed
2. Costs are sunk
3. Costs are avoidable
4. Costs are incurred

Use the following information to answer the next four questions:

A clothing manufacturing firm is deciding whether to invest in a new technology that needs an initial investment of \$45,000. This will increase cash flows in the first year by \$25,000 and \$30,000 in the second year. The firm’s current fixed costs are \$9,000 and marginal cost is

\$15. The firm currently charges \$18 per unit.

1. If the interest rate is 5% then the net present value of these cash flows is a) \$6,020.41

b) \$7,380.95

c) -\$7,380.95

d) \$10,000

1. If the interest is 5%, should the firm undertake the investment?
1. Yes, since NPV=0
2. Yes, since NPV<0
3. Yes, since NPV>0
4. No, since NPV=0

1. What’s the firm’s contribution margin?

a)   \$15

b)   \$18

1. \$3
2. \$4

1. The break-even quantity is a) 3000

b)   600

c)   500

d) 300

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