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Economics

1. Please prepare and submit your solutions to the THREE cases below.

Case A

Electricar Inc. is considering expanding manufacturing capacities in Asia. This would involve an initial investment of 4 billion RMB . The plant will start production after one year. It is expected to last for five years and a have a salvage value and the end of this period of 500 million RMB in real terms. The plant will produce 100 000 cars a year. The firm anticipates that in the first year it will be able to sell each car for 65 000 RMB, and thereafter the price is expected to increase by 4% a year.

Raw materials for each car are forecasted to cost 20 000 RMB in the first year and these costs are predicted to increase by 3% yearly. Total labor costs for the plant are expected to be 1.1 billion RMB in the first year and thereafter will increase by 7% a year. The land on which the plant is built can be rented for five years at a fixed cost of 300 million RMB a year payable at the start of each year. Electricar Inc. discount rate for this type of projects is 10% (nominal). The expected rate of inflation is 5%. The plant can be depreciated straight-line over the five-year period and profits will be taxed at 20%. Assume all cash flows occur at the end of each except where otherwise stated.

What is the NPV of the project plant for Electricar Inc ?

Case B

A gadgets producer currently manufactures 300000 units per year. It buys gadgets lids from an outside supplier at a price of 2,1 USD per lid. The plant manager believes that it would be cheaper to make these lids rather than buy them. Direct production costs are estimated to be only 1,6 USD a lid. The necessary machinery would cost 155000 USD and would last 10 years. This investment could be written off for tax purposes using the seven-year accelerated tax depreciation schedule. The plant manager estimates that the operation would require additional working capital of 32000USD but argues that this sum can be ignored since it is recoverable at the end of the 10 years. If the company pays corporate taxes at a rate of 35% and the opportunity cost of capital is 15%, would you support the plant managers proposal? State clearly any additional assumptions that you need to make to support your position.

Case C

Marta Daniels has bought a used horse transporter for her Kentucky estate. It costs 30000 USD. The project is to save on transporter rentals. Mrs Daniels had been renting a transporter every other week for 220USD per day plus 1,1USD per mile. Most of the trips are 80 or 100 miles in total.
Mrs Daniels usually gives the driver a 35USD tip. With the new transporter Mrs Daniels will only have to pay for diesel fuel and maintenance, at about 0,40USD per mile. Insurance costs for Mrs Daniels  transporter amount to 1200USD per year. The transporter will probably be worth 10000USD (in inflation-adjusted terms) after eight years, when Martas horse will be ready to retire.
Is the transporter a positive-NPV investment? Assume a nominal discount rate of 9% and a 2,5% forecasted inflation rate. Martas transporter is a personal investment, not a business or financial outlay, so taxes can be ignored.

2. Answer the below question and make a constructive comment on your peers comments. Cite the sources consulted and include the references at the end.

– If your incomes increases by 20 percent, how much would your quantity demanded of one specific good or service would change per month on average? Estimate your income elasticity for this good or service and explain your answer.

Peers’ comments (Marta):

1. If your incomes increases by 20 percent, how much would your quantity demanded of one specific good or service would change per month on average? Estimate your income elasticity for this good or service and explain your answer.

If we assume that we have a total monthly income of 2000, after the increase it will turn to 2400 (20 % increase).

Price elasticity of demand is a measure of the extent to which the quantity demanded of a good changes when the price of the good changes.

To determine the price elasticity of demand, we compare the percentage change in the quantity demanded with the percentage change in price.

From this 2000, I had a spent on this good of 1800that now it is 2100.

Percent change in price =(( New Price – Initial Price )/Initial Price)*100

Percent change in price = ((2000/1800)/1800)*100

Percent change in price= 0.06%

Now, lets check the income elasticity demand:

Income elasticity of demand is a measure of the extent to which the demand for a good changes when income changes, other things remaining the same.

Income elasticity of demand = Percentage change in quantity demanded / Percentage change in income.

Income elasticity demand = (2100-1800/1800) / ((2400-2000)/2000)

Income elasticity demand = 0.833^ –> This means that it is a basic or normal good/service.

 

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