Homework 1

Managerial Economics

1. Buy or Lease?

Consider the problem of whether or not to buy or lease a new piece of equipment. You know you only

need it for 4 years, and you can purchase it or lease it.

The lease requires a down-payment of $3,000 upon signing the lease and then a monthly payment of

$120 due at the end of each of the next 48 months. At the end of the lease the equipment goes back to

the dealer.

If you purchase the equipment you buy it for $15,000 in cash, and at the end of the 48 months you will

sell the equipment for $7,000.

Assume the monthly interest rate is 0.6%.

Calculate the present discounted value (cost) of your options of leasing or buying this piece of

equipment. Which option should you take and why?

2. Considering Two Different Projects

An investor is considering two different projects. Project 1 requires an initial investment of $75 and

returns $100 at the end of 1 year. Project 2 requires an initial investment of $150 and then returns $100

at the end of 1 year and another $100 at the end of 2 years.

(a) Calculate the internal rate of return on Project 1.

(b) Suppose for discounting the investor’s interest rate is 8% per year. Calculate the present value

of Project 2. Do the same for Project 1.

(c) Which project would you choose first if you used the maximize NPV rule? What about if your

objective is to shorten the payback period? Lastly, what if you use the Profitability Index or the

BC Ratio to guide your decisions?

(d) For what interest rates is the present value of Project 1 greater than that of Project 2?

To solve this, set the expressions for NPV of the two projects equal to each other:

3. Consider the following supply and demand curves for tickets to Oakland A’s games, where Q is

measured in hundreds of tickets per game.

Qd = 100 – 2P

Qs = 20 + 3P

Answer the following questions with regard to these equations:

a. Solve for the equilibrium price and quantity for this market.

b. Depict this market graphically. Fully label your graph, including the y-intercept and the

equilibrium price and quantity.

c. What would happen if bay area residents increase their preferences for A’s games? Illustrate the

effect on the market graphically, and discuss how you would expect equilibrium quantity and

price to change.

d. What would happen if stadium workers’ wages increased? Illustrate the effect on the market

graphically, and discuss how you would expect equilibrium quantity and price to change.

e. What would happen if the price for San Francisco Giants tickets increased? Illustrate graphically,

and discuss how you would expect equilibrium quantity and price to change.

4. Suppose the benefits of hiring an additional salesman depends upon how much he actually sells

for your company. The benefits to your firm can be expressed using the following equation: