1-2.

For every penny that the price of gasoline goes up, the US postal service (USPS)
experiences a monthly fuel cost increase of $8 million. State what assumptions you nee
to make to answer this question: How many mail delivery vehicles does the USPS have
in the United States?

Answer: One cannot simply answer the problem since there are insufficient information for us to
solve the problem. Information such as how much gas a truck consumes and mileage of delivery
are at least(in average) needed so that we can say how many delivery trucks there are.

US postal service (USPS)

what assumptions you need
ehicles does the USPS have

ufficient information for us to

mes and mileage of delivery
ry trucks there are.

2-11. A large, profitable commercial airline company flies 737-type aircraft, each with a
of 132 passengers. Company literature states that the economic breakeven point with
passengers. (2.2)
a. Draw a conceptual graph to show total revenue and total costs that this company is

Income
Fixed Costs
Variable Co

b. Identify three types of fixed costs that the airline should carefull examine to tlower
your reasoning.

Fixed costs that could change the Breakeven point from 62 passengers to a lower number incl
costs (by re-negotiating premiums with the existing insurance company or a new company), lower
front office, increased health insurance costs for the employees (i.e. lowering the cost of the prem
raising the deductibles on the group policy

c. Identify three types of variable costs that can possibly be reduced to lower the brea
select these cost items?

Variable cost that could be reduced to lower the break-even point include: no more meals on fl
throughout the cabin, fewer flight attendants. Note: One big cost is fuel, which is fixed for a given
speed. The captain can fly the aircraft at a lower speed to save fuel.

ircraft, each with a maximum seating capacity

akeven point with these aircraft is 62

at this company is experiencing.

Income
Fixed Costs
Variable Costs

examine to tlower its breakeven points. Explain

a lower number include: reduced aircraft insurance

new company), lower administrative expenses in the
the cost of the premiums to the airline company) by
to lower the breakeven point. Why did you

: no more meals on flights, less external air circulated

h is fixed for a given flight but variable with air

4-102 A mortgage banking company has been evaluating the merits of a

50-year mortgage (in addition in their popular 30-year mortgage). The
basic idea is to reduce the monthly payment and make home ownership
more affordable. The APR of either mortgage is 6% and the compounding
is monthly.
For a mortgage loan of $300,000, what is the difference in monthly payment for
the 30-year mortgage and the 50-year mortgage
For a 30-year loan:
A = $300,000(A/P, 0.5%, 360) = $300,000(0.0060) = $1,800 per month

For a 50-year loan

A = $300,000(A/P, 0.5%, 600) = $300,000(0.0053) = $1,1590 per month

$1,800 - $1,590 = $210

The difference is $210 per month.

What is the difference in total interest paid between the two mortgages?

For 30-year:
Total interest paid = $1,800(360) - $300,000 = $348,000
For 50-year:
Total interest paid = $1,590(600) - $300,000 = $654,000

$654,000 - $348,000 = $306,000

The difference is $306,000.

5-11 Last month, Jim purchased $10,000 of US treasury bonds (their face value was $10
These bonds have a 30-year maturity period, and they pay 1.5% interest every three mo
the APR is 6% and Jim receives a check for $150 every three months). But interest rates
similar securities have since risen to a 7% APR because of interest rate increases by the
Rserve Board. In View of the interest-rate increase to 7%, what is the current value of Ji
bonds?

Answer:
Vn = $10,000 (P/F,1. 5%,120) +$150 (P/A, 1.75%,120)
= $10,000(0.1247) + $150(50.0171)
= $8,750

$10,000 8,750 = $1,250

The worth of Jims bond had dropped by $1,250 because of the increase in the marketplace interes
long-term debt. With bonds, as the interest rate in the economy goes up, the value of the bond dec
and vice versa

ace value was $10,000).

est every three months(i.e.,
But interest rates for
te increases by the Federal
current value of Jims

marketplace interest rates for

alue of the bond decreases

6-4 Three mutually exclusive design alternatives are being considered. The estimated s
below. The MARR is 20% per year.

Annual revenues are based on the number of units sold and the selling price. Annual ex
Determine which selection is preferable based on AW. State your assumptions.

A
Investment cost $30,000

$60,000

$40,000

Estimated units
to be sold/year

15,000

20,000

18,000

Unit selling
price, $/unit

$3.10

$4.40

$3.70

Variable costs,
$/unit

$1.00

$1.40

$0.90

Annual
expenses (fixed
costs)

$15,000

$30,000

$25,000

Market value
Useful life

$10,000
10 years

$10,000
10 years

$10,000
10 years

Answer:
Assume all units are produced and sold each year.
AWb(20%) = -$6,000 (A/P,20%,10) + 20,000 ($4.40 - $1.40) - $30,000 + $10,000 (A/F,20%,10)
$16,075
AWC(20%) = -$40,000 (A/P,20%,10) + 18,000 ($3.70 - $0.90) - $25,000 + $10,000 (A/F,20%,10
$16,245
*Select design C to minimize annual worth

dered. The estimated sales and cost data for each alternative are given

selling price. Annual expenses are based on fixed and variable costs.
r assumptions.

0 + $10,000 (A/F,20%,10) =

00 + $10,000 (A/F,20%,10) =

7-8 An asset for drilling was purchased and placed in service by a petroleum production
basis is $60,000, and it has an estimated MV of $12,000 at the end of an estimated usefu
Compute the depreciation amount in the third year and the BV at the end of the fifth yea
these methods:
The SL method
The 200% DB method with switchover to SL
The GDS
The ADS

-1

Year, k
1
2
3
4
5

Beginning of
Year BVa
$60,000.00
51,428.57
44,081.63
37,784.25
32,386.50

(2)200%
(3) Depreciation Method
Declining
Balance
Straight-Line
Methodb
Method c
$8,571.43
$3,428.57
7,346.94
3,032.97
6,297.38
2,673.47
5,397.75
2,344.02
4,626.64
2,038.65

-4
Depreciation
Amount Selectedd
$8,571.43
7,346.94
6,297.38
5,397.75
4,626.64

a. Column 1 for year k - column 4 for year k = the entry in column 1 for year k+1
b. Column 1 x (2 / 14)
c.Column 1 minus estimated SVN divided by remaining years from the beginning of the current y
year.
d. Select the larger amount of column 2 or column 3.
From the above table,
d3 = $6,297.38 and BV5 = $32,386.50 - $4,626.64 = $27,759.86

From Table 7-2, the GDS recovery period is 7 years. d 3 = $60,000 (0.1749) = $10,494
BV5 = $60,000 - $60,000 (0.1429 + 0.2449 + 0.1749 + 0.1249 + 0.0893)
= $13,386

From Table 7-2, the ADS recovery period is 14 years.

$60,000^
d1 = d15 = (0.5)($60,000/14) = $2,142.86
d2 = d3 =...= d14 = ($60,000/14) = $4,285.71
BV5 = $60,000 - [$2,142.86 + 4($4,285.71)] = $40,714.30

etroleum production company. Its cost

of an estimated useful life of 14 years.
he end of the fifth year of life by each of

year k+1

eginning of the current year through the fourteenth

9) = $10,494
3)

9-15 A small high-speed commercial centrifuge has the following net cash flows
and abandonment values over its useful life. The firms MARR is 10% per year.
Determine the optimal time for the centrifuge to be abandoned if its current MV is
$7,500 and it wont be used for more than five years.

End of Year
1
2
Annual revenues le $2,000
$2,000
Abandonment value $6,200
$5,200
Answer:
Keep for N = 1 year:
PW (10%) = -$7,500 +
Keep for N = 2 years:
PW (10%) = -$7,500 +
Keep for N = 3 years:
PW (10%) = -$7,500 +
Keep for N = 4 years:
PW (10%) = -$7,500 +
Keep for N = 5 years:
PW (10%) = -$7,500 +

3
$2,000
$4,000

4
$2,000
$2,200

5
$2,000
$0

($6,200 + $2,000)(P/F,10%,1) = -$45

$2,000(P/A,10%,2) + $5,200(P/F,10%,2) = $268
$2,000(P/A,10%,3) + $4,000(P/F,10%,3) = $479
$2,000(P/A,10%,4) + $2,200(P/F,10%,4) = $342
$2,000(P/A,10%,5) = $82

PW (10%) is a maximum at 3 years. Therefore, the centrifuge should be retained for three
years before

et cash flows
% per year.
ts current MV is

etained for three

Consider these two alternatives.

A.Suppose that the capital investment of Alternative 1 is known with certainty. By ho
would the estimate of capital investment for Alternative 2 have to vary so that the in
based on these data would be reverse? The annual MARR is 15% per year.
B. Determine the life of Alternative 1 for which the AWs are equal

Capital investment
Annual revenues
Annual Expenses
Estimated market value
Useful life

Alternative 1
$4,500
$1,600
$400
$800
8 years

Alternative 2
$6,000
$1,850
$500
$1,200
10 years

(A)
AW1(15%) = -$4,500(A/P,15%,8) + $1,600 - $400 + $800(A/F,15%,8)
= -$4,5000(0.2229) + $1,200 + $800(0.0729)
= $225

AW2(15%) = -$6,000(A/P, 15%,10) + $1,850 - $500 + $1,200(A/F,15%,10)

= -$6,000(0.1993) + $1,350 + $1,200 (0.0493)
= $213
Therefore, the initial decision is to select Alternative 1. To determine the capital investment of A
2 (I2) so that the initial decision would be reversed, equate the AWs:
AW1(15%) = AW2(15%)
$255 = -I2 (A/P, 15%, 10) + $1,350 + $1,200 (A/F, 15%, 10)
$255 = -I2 (0.1993) + $1,350 + $1,200 (0.0493)
I2 = $5,791
The capital investment of Alternative 2 would have to be $5,791 or less for the initial decision t
reversed.
(B)
Set AW1(15%) = AW2(15%) and solve for N assuming market values remain constant.
-$4,500 (A/P,15%,N) + $1,200 + $800 (A/F,15%,N) = $213 -$4,500 (A/P, 15%, N) + $986.64 + $
15%, N) = 0
By trial and error, N = 7.3 years.

nown with certainty. By how much

have to vary so that the initial decision
15% per year.
equal

%,8)

15%,10)

ne the capital investment of Alternative

s:

r less for the initial decision to be

s remain constant.
0 (A/P, 15%, N) + $986.64 + $800 (A/F,

12-2 A bridge is to be constructed now as part of a new road. An analysis has show
at the present time. Because of uncertainty regarding future use of the road, the ti
studied. The estimated probabilities of having to widen the bridge to four lanes at v

Widen Bridge in
3 years
4 years
5 years
6 years

Probability
0.1
0.2
0.3
0.4

The present estimate cost of the two-lane bridge is $2,000,000. If constructed now
widening a two lane bridge will be an extra $2,000,000 plus $250,000 for every ye
what would you recommend?

Answer:

Build the 4-lane bridge now:

PW = -$3,500,000
Build 2-lane bridge now, add two lanes later:
Year of
Expansion
k
3
4
5
6

E(PW) = - $2,000,000 - $1,957,450(0.1) - $1,906,500(0.2) - $1,844,050(0.3)

$1,773,100(0.4)
= -$3,839,500
Decision: The four-lane bridge should be built now.

w as part of a new road. An analysis has shown that traffic desntiy on the new road will justify a two
tainty regarding future use of the road, the time at which an extra two lanes will be required is cur
f having to widen the bridge to four lanes at various times in the future are as follows:

-lane bridge is $2,000,000. If constructed now, the four-lane bridge will cost $3,500,000. The future
n extra $2,000,000 plus $250,000 for every year that widening is delayed. If money can earn 12% pe

ter:

[$2,000,000
[$2,000,000
[$2,000,000
[$2,000,000

+
+
+
+

PW of Expansion Expenses
(3)($250,000)](P/F,12%,3) = (4)($250,000)](P/F,12%,4) = (5)($250,000)](P/F,12%,5) = (6)($250,000)](P/F,12%,6) = -

1) - $1,906,500(0.2) - $1,844,050(0.3)

be built now.

$1,957,450
$1,906,500
$1,844,050
$1,773,100

road will justify a two-lane bridge

will be required is currently being
s follows:

$3,500,000. The future cost of

money can earn 12% per year,

13-2 The Caterpillar Company has a beta (a measured common stock volatility) of 1.28. Wh
estimated cost of equity capital based on the CAPM when the risk-free interest raise is 2.5%
Answer:

Ea= 0.25 + 1.28(0.084) = 0.1325 or 13.25%

volatility) of 1.28. What is its

interest raise is 2.5%?

14-2 List two advantages and two disadvantages of noncompensatory models for dealin
attribute decision problems. Do the same for compensatory models.

Answer:

Noncompensatory Models: Full dimensional

Advantages:
-Quick and easy to apply to eliminate one or more of the alternatives.
-All attributes are considered in the analysis.
-Simple, easy to understand, requires little computation if any.
Disadvantages:
-Very often does not lead to a final selection.
-May not eliminate any of the alternatives.
-Tends to satisfice rather than optimize.

Compensatory Models: Single dimensional

Advantages:
-Trade offs are taken into account in arriving at the final decision.
-Will almost always arrive at a final choice, and method may be developed to break a tie quantitati
-Numerical answers seem to parallel intuitive choices.
-All worths reduced to a single scale, makes complex problem computationally tractable.

Disadvantages:
-Weighting is still subjective.
-Compression to numerical values for qualitative subjective data is often difficult and time consum
not be meaningful;
-Translation of numerical or subjective values to a single scale may not be plausible for all individua

y models for dealing with multi-

break a tie quantitatively.

lly tractable.

ult and time consuming, -and may

usible for all individuals.