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In order to
celebrate your graduation you decide to throw a large party.
In order to finance the party you apply your ECN306 skills to run
an espresso bar in the Memorial Union for the next 50 weeks.
The party is in 50 weeks so everything must be finished,
equipment sold, etc. no more than 50 weeks hence.
Fortunately, the Memorial
Union Board grants you exclusive rights to operate the espresso bar.
In other words, you can act like a profit maximizing monopolist.
Marketing surveys indicate the demand function for cups of
espresso per week is:
Q
= 40 - P
The variable cost of
producing a cup of espresso is $5.00, labor and machinery are both
independent of output (fixed cost).
There are two types of
machines you can buy. Each
type has a different depreciation rate, a different labor requirement,
and a different purchase price.
Machine 1
Machine 2
Depreciation
rate
0.01/wk
0.02/wk
Wage
bill
$100/wk
$50/wk
Purchase
price
$3,000
$4,000
Your job is to write a report
that answers the following sets of questions:
·
What price will you charge per
cup, What quantity will you sell? Compute
the gross revenue, total costs, and profit per week. You will probably have two answers—one for each machine.
·
Compute the present value and
future value (don't forget to sell the depreciated machine) for each
type of machine installation. Which
machine will you purchase?
·
Suppose the purchase price on the
machine you decided not to buy is lowered.
At what price will it become competitive?
·
Graph the present value of both
installations as a function of the interest rate. Is there an interest rate at which you would purchase the
other machine? What is the
internal rate of return for both installations?
Which machine has the higher internal rate of return? Is it the same machine you chose using present value?
Explain.
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