Managerial Economics

1. Supply and Demand. Using the following two functions to answer the questions below.
Pdemand = 25.50 – 3Q
P
supply = 5.50 + 2Q
a. Algebraically derive the equilibrium function of supply and demand. Hint: just the function (do not calculate).
b. What is the equilibrium price and equilibrium quantity? How do you interpret these numbers?
c. Graph the supply and demand curves.
d. What would be the result if the firm implements a price increase? Why?
e. Assume an interest rate decrease affecting consumer’s disposable income. What would be the
behavior of the demand curve? Explain in detail.
2. Discounting and Net Present Value. Assume you are the CFO of a manufacturing company and are
deciding to choose between three different projects which have different cash flows and different cost
of capital.

Project Cost of Capital CF0 CF1 CF2 CF3
A 10% -10 +30 +5 +5
B 5% -10 +5 +15 +10
C 15% -5 +20 +10 +5

a. What is the present value of all individual cash flows?
b. What is the
net present value of each project? How do you interpret these numbers?
c. Assume that you have enough capital to invest in two projects. Which two projects would you
choose? Why?
d. Assume your CEO challenges your suggestion without conducting any analysis. The only number the
CEO is basing their argument is by the cost of capital? Would this approach be right? Why or why not?
How would you defend your choice?
3. Costs & EVA: You are the owner of a private company who uses only earnings to run the business.
Your firm will launch a new product line starting 2021. The projected production is 10,000 units a
month and is projected to incur the following costs: labor $125/unit, materials $45/unit, rent
$250,000/month, marketing & advertising campaign $75,000 (total), and accounting & litigation services
$25,000 (total).

Your Firm, LLC
Income Statement
December 31, 2020
Net Sales $10,000,000.00
Cost of Salesa $300,000.00
GROSS PROFIT $9,700,000.00
Operating Expenses:
SG&Ab $270,000.00
Depreciation & Amortization $20,000.00
Total Operating Expenses $290,000.00
OPERATING INCOME $9,410,000.00
Other Income (Expense):
Net Interest $0.00
Other Income $0.00
Total Other Income (Expense): $0.00
EARNINGS BEFORE PROVISION
FOR INCOME TAXES
$9,410,000.00
Provision for Income Taxes ($1,976,100.00)
NET EARNINGS $7,433,900.00

a Cost of Sales is composed of costs related to 1) direct material, 2) direct labor cost, 3) cost of storing products, and 4)
overhead.
b SG&A Expense is composed of costs related to non-production expenses. Examples are 1) rent, 2) marketing & advertising
services, 3) accounting & litigation services, 4) travel expenses, among others.
a. What is the yearly production and yearly total costs? What percentage of total costs is composed of
variable costs?
b. Assume that you will cover total costs with 32% of your 2020 earnings and the remaining balance you
will finance it with debt (80%) and equity (20%). How much financing will you need? How much will
investors finance?
c. What is your
weighted average cost of capital (WACC) if investors expect a 20% return and the bank
rate is 10%?

d. BONUS (10 PTS TOWARD EXAM). Assume no changes to the established product lines, no
depreciation or amortization, tax rate is 21%, and selling price of the new product is set at $699.99/unit.
Does the firm earn an economic profit? If so, how much?
Hint: create a new income statement and don’t forget interest
payments made to the bank loan (use the Excel CUMIPMT formula).
4. Break-Even Analysis. Last year, a toy manufacturer introduced a new toy truck that was a huge
success. The company invested $2.5 million for a plastic injection-molding machine (which can be sold
for $2 million) and $100,000 in plastic injection molds specifically for the toy (not valuable to anyone
else).
Labor and the cost of materials necessary to make each truck are about $3.00.
This year, a competitor has developed a similar toy that has significantly reduced demand for the toy
truck. Now, the original manufacturer is deciding whether it should continue production of the toy
truck.
a. If the estimated demand is 100,000 trucks, what is the break-even price for the toy truck?
b. Should the company shut down? Why or why not?

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