eco204_HW_17 - University of Toronto, Department of...

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Unformatted text preview: University of Toronto, Department of Economics, ECO 204 2008‐2009 S. Ajaz Hussain ECO 204 2008‐2009 Ajaz Hussain HW 17 Question 1 This question is based on the “Resource allocation problem across 3 divisions” in Lecture 19. In that example, we recognized the importance of making decisions on the basis of marginal analysis (see Lecture 18). Ajax Private Equity (PAE) has unlimited funds to invest owing to Ajax’s uncle Sad‐damn Hussain having left Ajax vast sums of money before he was unceremoniously hanged. Ajax’s financial advisor, “Trust me, my name is Madoff”, has identified the following seven projects as investment opportunities: Project A B C D E F G Initial Investment $1m $0.4m $0.3m $0.1m $0.2m $0.2m $0.1m (a) Given that you have unlimited funds which project should you invest in? NPV $2m $1.4m $1.2m $0.6m $0.5m $0.3m $0.05m 1 University of Toronto, Department of Economics, ECO 204 2008‐2009 S. Ajaz Hussain (b) Due to a typo in Uncle Sad‐damn’s will, Ajax finds out that he only has $1m. Unable to afford Madoff Advisors he engages an MBA from McGrill University in Montreal who tells you that you since you only have a $1m, you should invest in the feasible project with the highest NPV. Is he correct? Hint: look at the NPV per $ invested. Question 2 (Summer 2008 Test 3 Question) After graduating from UT’s Commerce program, you fulfill your life‐long dream to produce a movie. You’ve just finished work on “The Dark Monopolist”, based on the life of a nefarious criminal Sad van Dam Hussain. The movie cost $50m to produce. Assume the MC of “printing” movies on films is negligible. If the movie is released into theaters the revenues as a function of the number of weeks in theaters is: R(w) = 10w ‐ 0.25w2, where R is millions of dollars and w is the number of weeks the movie is shown in theaters. (a) What is the optimal number of weeks the movie should be shown in theaters? Show all steps clearly. (b) Movies are often released into the DVD rental market after being first released in theaters. Suppose the movie yields $4m in profits per week in the DVD rental market. What is the optimal number of weeks that movie should be shown in theaters? Assume the movie cannot be shown in theaters and released on DVDs simultaneously. Show all steps clearly. Question 3 In Lecture 19 we discussed the Net Present Value (NPV) and Internal Rate of Return (IRR) rules for investment decisions where the decision is to either invest or not invest. We discussed that in micro and finance the value of not investing is $0 and not the interest you’d get by putting the investment money into (say) the bank because the opportunity cost of investment ‐‐ putting money into the bank ‐‐ is built into the PV calculations. Let’s see if this is true. You have the opportunity to buy land for $10,000. You are sure that five years from now it will be worth $20,000. Suppose you can earn 8% a year by investing your money in the bank. (a) Should you buy the land? Use the NPV rule and verify your answer by comparing the Future Values (FV) of the land with the FV of putting your money in the bank at 8% interest. (b) Should you buy the land? Use the IRR rule. 2 ...
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This note was uploaded on 05/02/2011 for the course ECO 204 taught by Professor Hussein during the Fall '08 term at University of Toronto- Toronto.

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