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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 shortrun, a firm’s decision to shutdown 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
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 shortrun, a firm’s decision to shutdown 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
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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 shortrun, a firm’s decision to shutdown 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. This will increase cash flows in the first year by $600 for the next two years.
 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
 If the cost of capital increased to 25%, does the firm invest in the printer?
 Yes because the NPV>0
 Yes because the NPV=0
 Need information on the marginal benefits and costs
 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.
 What’s the firm’s contribution margin?
a) $12
b) $10
 $8
 $4
 The breakeven quantity is a) 1250
b) 625
c) 416.67
d) 500
 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
 Shutdown as the firm is making a loss of $10,000 per week
 Shutdown as the firm cannot cover the fixed costs
 Continue operating as the firm is covering all the variable costs and some of the fixed costs
 Shutdown because it is cost effective to pay off the remaining fixed costs
 Based on the above information, at what price does the firm consider shuttingdown?
a) $25
 $0
c) $15
d) $10
 What are some of the solutions for a holdup problem?
 Mergers

 Contracts
 Exchange of ‘hostages’
 All the above
 The higher the interest rates
 the more value individuals place on future dollars
 the more value individuals place on current dollars
 less investments will take place
 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.
 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
 If the cost of capital decreased to 1%, does the firm invest in the new technology?
 Yes because the NPV>0
 Yes because the NPV=0
 Need information on the marginal benefits and costs
 No because the NPV<0
 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
 Shutdown as the firm is making a loss of $15 million per week
 Shutdown as the firm cannot cover the variable costs
 Both a and b
 None of the above
 Based on the above information, at what price does the firm consider shuttingdown?
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.
 What’s the firm’s contribution margin?
a) $1800
b) $800
c) $1000
d) $300
 The breakeven quantity is a) 10000
b) 5,555
c) 12,500
d) 5,000
 A firm will shut down in the shortrun if
 P>AVC
 P<AVC
 Profits<0
 P<ATC
 A firm will shut down in the longrun if
 P>AVC
 P<ATC
 P=ATC
 P>ATC
 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
 incurring a loss of $2.00 per unit and should shut down.
 realizing only a normal profit.
 realizing an economic profit of $2.00 per unit.
 incurring a loss per unit of $2.00, but should continue to operate in the short run.
 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
 Should shutdown as its making a loss of $2
 Should continue operating as long as it is covering the variable costs of $6
 Should continue operating as long as it is covering the fixed costs of $4
 Should not shut down
 In order to continue its operations, in the longrun a firm must
 Charge a price that is equal to its AVC
 Charge a price that is equal to its AFC
 Charge a price that is equal to its AVC + AFC
 Need more information to determine the price
 The breakeven quantity is
 Fixed Costs/Price
 Fixed Costs/Marginal Cost
 Fixed Costs/(Price – Marginal Costs)

 Contribution Margin/Fixed Costs
 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
 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
 Breakeven quantity is a point where
 Level of profit is maximized
 Level of cost is minimized
 Only variable costs are covered
 There is neither a profit nor a loss
 If a firm sells more than the breakeven quantity,
 It will make a profit
 It will only cover the variable costs
 It will make a loss
 A firm is unable to sell above the breakeven quantity
 Which of the following variables is not needed to determine the breakeven quantity?
 Marginal costs
 Fixed Costs
 Selling Price
 Average Costs
 Which of the following is classified as a sunk cost?
 Cost of the next best alternative
 Additional cost of producing an additional unit
 Research costs to determine the implementation of a technology
 Total cost of producing a product
 Which of the following will increase the breakeven quantity?
 A decrease in overall fixed costs
 A decrease in the marginal costs
 A decrease in the price level

 An increase in price level
 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 shortrun, how low can price go before it is profitable to shut down?
a) $150
b) $250
c) $250.20
d) $400
 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 longrun, 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.
 At what quantity is Sarah Machinery indifferent between two technologies?
 5
 6
 7
 8
 What is the total cost at the breakeven quantity calculated above?
a) $750
b) $850
c) $950
d) $1050
 If the company plans to produce 9 machines, which technology should the firm choose?
 The lowmarginalcost technology
 The highmarginalcost technology
 Either technology because they are equally cost efficient
 Need more information
 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
 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
 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.
 Which firm has higher fixed costs?
 Jim’s Production
 Competitor
 They both have the same fixed costs
 Need more information
 Which firm has higher marginal costs?
 Jim’s Production
 Competitor’s production
 They both have the same fixed costs
 Need more information
 At what quantity is Jim’s Production indifferent between two technologies? a) 5000
b) 7500
c) 10000
d) 12500
 What is the total cost at the breakeven quantity calculated above?
a) $750
b) $1000
c) $1500
d) $2000
 If the company plans to produce 5000 units of output, is acquiring the competitor’s technology a good idea?
 Yes, because the competitor has a lowmarginalcost technology
 Yes, because the competitor has a highmarginalcost technology
 Yes, because the company plans to produce less than the breakeven quantity
 Both b and c
 If firms anticipate that they are at risk of being held up, firms are more likely to adopt contracts or organizational forms such as
 investments in reputation
 mergers
 exchange of “hostages”
 All the above
 Firms that anticipate holdup, choose organizational or contractual forms
 To give each party both the incentive to make relationshipspecific investments
 To give each party both the incentive to ignore sunk costs
 To give each party both the incentive to reduce investments in reputation
 To give each party both the incentive to make nonspecific investments
 Holdup can only occur if
 Costs are fixed
 Costs are sunk
 Costs are avoidable
 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.
 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
 If the interest is 5%, should the firm undertake the investment?
 Yes, since NPV=0
 Yes, since NPV<0
 Yes, since NPV>0
 No, since NPV=0
 What’s the firm’s contribution margin?
a) $15
b) $18
 $3
 $4
 The breakeven quantity is a) 3000
b) 600
c) 500
d) 300