Question

1. Incremental Profits

Your firm, which currently sells its product only in South Texas, is considering starting to export your product across the border into Mexico. Currently, your firm’s revenues are $1,200,000 and your firm’s costs are $1,020,000. You estimate that if you start exporting to Mexico, your revenues will increase by $150,000 and your costs will increase by $200,000.

1. (3 points) What are your profits if you do not export your product to Mexico?

2. (3 points) What are your profits if you do export to Mexico?

3. (3 points) What are the incremental profits associated with exporting to Mexico?

4. (3 points) Should your firm export to Mexico? EXPLAIN WHY OR WHY NOT.

5. (3 points) Suppose that a previous manager had already decided to go ahead with the project (i.e., already decided to start exporting to Mexico). After spending $100,000 to start (but not finish) the exporting project, he was fired and you took the project over. You have to decide whether to continue with his project or not. If you continue, your additional revenue from exporting to Mexico will be $150,000 and your costs will be the $100,000 that the previous manager has already spent and $100,000 additional dollars that you will need to spend to complete the project. If you cancel the project, your firm will not start exporting, so additional revenue will be zero, but your only costs are the $100,000 the previous manager has already spent? Should you continue? EXPLAIN WHY OR WHY NOT.

Answer 1

Currently, firm’s revenues are $1,200,000 and firm’s costs are $1,020,000.

If the firm start exporting to Mexico, firm's revenues will increase by $150,000 and your costs will increase by $200,000.

A. When the firm do not export its product to maxico, Profit = Revenue - Cost = 1,200,000 - 1,020,000 = $180,000

B. If the firm export to Maxico, Profit = Total revenue - Total Cost = (1,200,000+150,000) - (1,020,000+200,000) = 1,350,000 - 1,220,000 = $130,000.

C. Incremental profit from exporting to Maxico = Profit after exporting - Initial profit = 130,000 - 180,000 = -$50,000

D. The firm shouldn't export to Maxico, because after exporting its profit has decreased by $50,000.

E. Suppose that a previous manager had already decided to go ahead with the project (i.e., already decided to start exporting to Mexico). After spending $100,000 to start (but not finish) the exporting project, he was fired and I took the project over. Now I have to decide whether to continue or not, this can be done by considering both the cases.

If I continue the project the final profit will be as calculated above(with export) i.e. $130,000

But if the project is canceled, there will be no additional revenue but the cost will be $100,000. So in this case the profit will be 180,000 - 100,000 = $80,000

In this case the project should be continued because canceling it will decrease the profit to a very low level as some cost is already incurred and cant be recovered.