APPLICATION QUESTIONS – Week 4
Questionl:
Ahmed bought a new Jeep Wrangler SE 4WD with a soft top two years ago for AED.208,500
using five-year interest-free financing. Today, the remaining loan balance is AED.36,900 and
Ahmed’s Jeep has a trade-in value of A8D.26,500. What is Ahmed’s opporrunity cost of
continuing to drive the Jeep? Discuss the financing risk exposure of the lender.
Question2:
Suppose the Big Enchilada restaurant has been offered a binding one-year lease agreement on an
attractive site in Dubai for AED. 200,000 per month. Before the lease agreement has been
signed, what is the incremental cost per month of site rental? After the lease agreement has been
signed, what is the incremental cost per month of site rental? Explain.
Question3:
Modern Merchandise, Inc. makes and markets do-it-yourself hardrvare, house ‘,vares, and
industrial products. The company’s new Electronic Bicycle is winning customers by virtue of its
high quality and quick order turnaround time. The product also benefits because its price point
bridges the gap between ready-made Bicycles and their high-priced custom counterpart. In
addition, the company’s expanding product line is sure to benefit from cross-selling across
different lines. Given the success of the Electronic Bicycle product, Modern Merchandise plans
to open a new production facility near Jabel Ali, Dubai. Based on information provided by its
chief financial officer, the company estimates fixed costs for this product of 550,000 per year
and average variable costs of:
AVC: $0.5 + $0.002sQ
Where, AVC is average variable cost (in US Dollars) and Q is output.
QUESTIONS:
A. Estimate total cost and average total cost for the projected first-year volume of 20,000
units.
B. An increase in worker productivity because of greater experience or learning during the
course of the year resulted in a substantial cost saving for the company. Estimate the effect
of learning on average total cost if actual second-year total cost was $848,000 at an actual
volume of 20,000 units.
Question4:
Emirates Airlines offers four flights per weekday from Dubai to Kabul, Afghanistan. if adding a
fifth flight per weekday would cost $15,000 per flight, or $110 per available seat. Calculate the
incrementai costs borne by Emirates follorving a decision to go ahead with a fifth flight per day
for a minimal 60-flight trial period. What is the marginal cost? ln this case, is incremental cost or
marginal cost relevant for decision making purposes?
Question5:
South Park Softrvare, lnc. produces innovative interior decorating software that it sells to design
studios, home furnishing stores, and so on. The yearly volume of output is 15,000 units. Selling
price and costs per unit are as follows:
Selling Price 5250
Costs:
Direct material $40
Direct labor 60
Variable overhead 30
Variable selling expenses 25
Fixed selling ex-penses 520,000
Other expenses S 75
Managemenl i:r e.raluating the possibility of using the Internet to seli its so{trvare directly to
conslrmers aL a price of 5300 per r.rnit. Although no added capital investment is required,
additional shipping and handling costs are estimated as follows:
Direct labor 530 pel unit
Variabie ovei.head S5 per unit
Variable seiling expenses 52 per unit
Fixed selling expenses S20,000 pe1’year
Calculate
A. The total cost and protit while the selling price per unit rvould be 5250.
B. The incremental profit that South Park lvould eam by customizing its instruments and
market them directiy to end users.
Question6:
Textbook publishers evaluate market size, the degree of competition, expected revenues, and
costs for each prospective new title. With these data in mind, they estimate the probability that a
given book will reach or exceed the breakeven point. If the publisher estimates that a book will
not exceed the breakeven point based upon standard assumptions, they may consider cutting
production costs by reducing the number of illustrations, doing only light copy editing, using a
lower grade of paper, or negotiating with the author to reduce the royalty rate. To illustrate the
process, consider the following data:
Fixed Costs:
Copyediting and other editorial costs S15,750
illustrations 32,750
Typesetting 51,500
Total fixed costs $100,000
Variable Costs:
Printing, binding and paper $22.50
Bookstore discounts 25.00
Sales staff commissions 8.25
Author royalties 10.00
General and administrative costs 26.25
Total variable costs per copy 592.00
List price per copy $ 100.00
Fixed costs of $100,000 can be estimated quite accurately. Variable costs are linear and set by
contract. List prices are variable, but competition keeps prices within a narrow range. Variable
costs for the proposed book are S92 a copy, and the expected wholesale price is $100. This
means that each copy sold provides the publisher with an $8 profit contribution.
A. Estimate the volume necessary to reach a breakeven level of output.
B. How many textbooks would have to be sold to generate a profit contribution of $20,000?
C. Calculate the economic profit contribution or loss resulting from the acceptance of a book
club offer to buy 3,000 copies directly from the publisher at a price of $77 per copy. Should the
offer be accepted?
