Economics- Activity2

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MANAGERIAL

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Finance

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Apr 3, 2024

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1. You own a plant that produces 10,000 copies per year. Your fixed costs are $50,000 per year. The marginal cost per copier is a constant $5. What is your break-even price? What would be your break-even price if you were to sell 70% more copiers? (A) Here fixed cost $50,000 Variable costs = $5*10,000 = $50,000 The total cost is $100,000 Per unit cost = $100,000/ 10,000 = $10 per unit cost. Break-even point where cost equals the price. So, the $10 price is a break-even price. (B) Where sales are more than 70%: 10,000 + 70% = 17,000-unit total Variable costs = $5 * 17,000 unit = $85,000 Fixed cost = $50,000 Total cost = $50,000+$85000 = $135,000 Per unit cost = $135,000 / 17,000 = $7.95 per unit cost So, here break-even price is $7.95 per unit.

2. Suppose you make an initial investment of $70,000 that will return $20,000/year for four years (assume the $20,000 is received each year at the end of the year). Is this a profitable investment if the discount rate is 15%? To determine if the investment is profitable, we need to calculate the net present value (NPV). NPV is the sum of the present values of all the cash flows associated with the investment, discounted at the appropriate rate. In this case, the initial investment is -$70,000 (a negative cash flow), and the annual returns are + $20,000 for four years. To calculate the present value of each of these cash flows, we use the formula: PV = CF / (1 + r)^n PV is the present value, CF is the cash flow, r is the discount rate, and n is the number of periods. For the initial investment, the present value is simply -$70,000 since it occurs at time zero. For the annual returns, we need to calculate the present value for each year and then sum them up. Using a discount rate of 15%, we get: PV of year 1 return = $20,000 / (1 + 0.15)^1 = $17,391.3 PV of year 2 return = $20,000 / (1 + 0.15) ^2 = $15,122.9 PV of year 3 return = $20,000 / (1 + 0.15) ^3 = $13,150.3 PV of year 4 return = $20,000 / (1 + 0.15) ^4 = $11,435.1 Summing up these present values, we get a total of $57,099.6

Finally, to calculate the NPV, we subtract the initial investment from the sum of the present values: NPV = -$70,000 + $57,096 = -$12,904 Since the NPV is negative, this investment is not profitable at a discount rate of 15%. In other words, the cost of the investment outweighs the expected returns, and it would not be wise to proceed with this investment. 3. A US company has revenue of $5.5 million and total costs of $7.5 million, which are or can be broken down into a total fixed cost of $3 million and a total variable cost of $4.5 million. The net loss on the firm’s income statement is reported as $2,000,000 (ignoring tax implications). In prior periods, the firm had reported profits on its operations. a. What decision should the firm make regarding operations over the short term? In the short term, the firm should evaluate its options and consider the following decisions:  Cost Reduction : The immediate concern is that the firm is incurring a net loss of $2 million. To mitigate this loss in the short term, the company should look for ways to reduce its costs. This could include cutting discretionary spending, renegotiating contracts, or even temporarily reducing staff or hours worked.  Price Adjustments : If possible, the firm could also consider increasing its product or service prices to cover the costs. However, this should be done carefully to avoid losing customers or damaging the brand.

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 Evaluate Variable Costs : Analyze the variable costs to see if there are any opportunities to reduce them without sacrificing the quality of the products or services. This might involve optimizing the supply chain or finding more cost-effective suppliers.  Evaluate Sales and Marketing Strategies : The company should assess its sales and marketing strategies to determine if there are ways to boost revenue. This could involve expanding into new markets, launching new products, or reevaluating the current marketing campaigns.  Cash Flow Management : Ensure proper cash flow management to meet short-term financial obligations. This might involve delaying non-essential expenditures or exploring options for short-term financing. b. What decision should the firm make regarding operations over the long term? In the long term, the firm should take a more strategic approach:  Business Model Assessment : Evaluate the sustainability of the current business model. If the company has been consistently reporting losses, it may need to rethink its strategy. This could involve diversifying its product or service offerings, entering new markets, or exploring strategic partnerships or mergers.  Investment in Efficiency : Consider making investments in technology and processes that can improve efficiency and reduce costs over the long term. Automation, for example, can lead to cost savings in the long run.  Revenue Growth : Focus on sustainable revenue growth by expanding the customer base, enhancing customer retention strategies, and exploring new revenue streams.

 Cost Management : Continue to manage costs effectively by regularly reviewing expenses and finding ways to optimize operations.  Financial Planning : Develop a long-term financial plan that includes realistic revenue and cost projections. Ensure that the company maintains adequate cash reserves and access to capital for future investments and emergencies. c. Assume the same business scenario except that revenue is now $5.0 million, and total costs of $7.5 million, which are or can be broken down into total fixed cost of $3 million and total variable cost of $4.5 million, which creates a net loss of $2.5 million. What decision should the firm make regarding operations in this case? In this scenario where revenue is $5.0 million and total costs are $7.5 million, resulting in a net loss of $2.5 million, the firm should take similar short-term and long-term actions as mentioned in parts (a) and (b) respectively. The fact that revenue has decreased while costs remain the same or have increased makes the situation even more urgent. Immediate cost-cutting measures, price adjustments, and a thorough reassessment of the business model are crucial steps to address the ongoing losses and ensure the company's long-term viability.