CLASS / COURSE: Business Economics
1. Consider the following Industry Demand and Industry Supply Curves represented by the equations below:
Supply: P = 200 + Q/8,500 Demand: P = 1500 – Q/7,000
a) Use Excel to plot the supply and demand curves on a graph. Ensure you have price on the vertical axis. Let the horizontal axis range from 0 to 10,000,000.
b) What is the equilibrium (market clearing) price? Be precise; give the exact number.
c) Suppose the above industry supply and demand curves are for the short run in an industry characterized by perfect competition. MBA Corp is one of many similar companies that operates in this industry.
i) What is the short-run demand curve faced by MBA Corp? Use Excel to plot it (over a range of Q from 0 to 1000) and also write an equation to represent it.
ii) For MBA Corp, write equations and use Excel to plot (for Q from 0 to 1000) the MC curve and AC curve given a total cost curve as follows: TC = 40,000 + 2.5Q2
iii) Using the data above, what is the optimal quantity MBA Corp should produce in the short run? What will be the resulting total revenue, total cost, and total economic profit?
iv) Given the results from (iii) what do you expect to happen in the long run to the industry supply curve (give a word description, no equations are necessary)? Explain.
v) Given (iv), what do you expect to happen to the demand curve faced by MBA Corp? Explain.
vi) Given (v), what will happen to the quantity produced, revenue, cost and economic profit of MBA Corp? Show relevant numbers.
2. Consider the following Industry Demand and Total Cost Curves for an industry characterized by monopoly:
Total Cost = 25,000 + 5Q3 Demand: P = 10,000 – 6Q2
a) What are the marginal cost, average cost, and marginal revenue curves faced by ABM Corp – the monopoly firm? Indicate the equations for these curves and use Excel to plot them and the demand curve over a range of Q from 0 to 50 and P from -10,000 to 30,000. Ensure you plot enough points to get smooth curves. Use an XY graph without the smoothing option.
b) At what level of quantity would ABM’s average cost be minimized?
c) What level of quantity does ABM Corp choose to produce?
d) What is the price charged, total revenue, total cost, and economic profit for ABM Corp?
e) What is the price elasticity of demand given the quantity ABM Corp chooses to produce? Interpret what the price elasticity of demand number you calculated implies about total revenue. What strategy implications might this mean for ABM Corp.
f) If this industry begins to become more competitive, what will happen to the demand curve faced by ABM Corp? No equations are necessary, but give a sufficient word description as to what will happen.
g) What actions might a corporation’s management take to maintain a competitive advantage? Consider both the cost side and the revenue side in your suggestions. Please be clear and concise.
3. Tacky Textiles buys some inventory from Calvin Klein in 2009 for $50,000 on credit terms and will pay for the inventory in 2010. In 2010 Tacky Textiles sells $30,000 of the inventory to The Bay for $45,000. The Bay will pay Tacky Textiles in 2011.
a) Indicate the cash flows caused by the above transactions. (Be specific in terms of years too.)
b) Indicate the effects on inventory caused by the above transactions. (Be specific in terms of years too.)
c) Indicate the effects on profitability (ignore taxes) caused by the above transactions. (Be specific in terms of years too.)
d) Do the cash flow numbers give the same indication of performance for Tacky Textiles as the profitability numbers? Explain briefly.
4. To start up a business its founders must invest as follows:
Following the times when you are investing, the business is projected to make positive cash flows. For year 5, the cash inflow is expected to be $5,000 and this is expected to grow at a rate of 100% each year ending with the cash flow that occurs at year 10. In year 11, the expected cash flow is $300,000 and following cash flows are expected to grow at a rate of 4% per year thereafter (and continuing in perpetuity).
a) If the risk of the business implies an appropriate discount rate of 20% per year, what is the economic profit generated by this business venture (i.e., what is the NPV of starting this business)?
b) What is the present value of the investment in the business (just the investing cash flows – the cash flows from year 0 to year 4)? Show how this can be calculated with the PV growing annuity equation.
c) Suppose the owners of the business do a public offering of the business on the stock market at the end of year 4 (just after the last investment cash flow) and the market has the same expectations of future cash flows (as stated above for years 5 onward).
i) What will be the market price of the business when it goes public (at year 4)?
ii) What would be the present value of this amount discounted back to year 0?
iii) What does this imply about the economic profit expected to be received by the people who buy the stock in the public offering?
iv) What does this imply about the economic profit expected to be received by the original founders of the business (refer to your answer to b)?
What is the IRR of this business? Hint, you may want to set up the first 10 years of cash flows on a spreadsheet and then bring in the growing perpetuity formula to handle the cash flows from year 11 onward. Then you can use Solver to determine the IRR. (Please use a screen capture printout to show the setup of Solver.)
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SUBJECTS / CATEGORIES:
2. Corporate Finance
3. Business Economics
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