Question

1.Assume that last semester you bought a textbook new for $77. Today, the same book sells new for $100, and used copies in the bookstore now sell for $75. The bookstore offers to buy back your book for $45. You would like to sell your book, and a student 25 who will be taking the course next semester wants to buy your book directly from you. At what range of prices should a sale take place between you and the other student?

2. Roulex has 500 watches that cost $15 each to manufacture. The watches are out of fashion and cannot be sold as is. They can be refitted at a cost of $4 per watch, and then sold for $18 each. Alternatively, the watches can be donated to charity for a net financial benefit (i.e., a reduction in the company’s tax liability) of 20% of the original production cost. A) Identify a sunk cost in the scenario described above. B) What should the company do? C) Quantify the opportunity

3. The Jennie Mae Frog Farm incurs production costs of $2 each time a frog is produced. In addition, the farm spends a lump-sum $5,000 each month for expenditures such as insurance, property taxes, and equipment leases, regardless of how many frogs are produced. Times are good: Jennie Mae is operating at capacity, and she is producing and selling 1,000 frogs per month. Jennie Mae’s usual sales price is $9 per frog. The U.S. Army has approached Jennie Mae and proposed a one-time purchase of 300 frogs. A) What is the lowest price Jennie Mae should be willing to charge the Army per frog? 27 B) Disregard your answer to part (A) and assume the Army offers to pay $6 per frog. What is the opportunity cost associated with each frog sold to the Army at this price? C) Now assume that times are not so good, and Jennie Mae has excess capacity to make 500 frogs. The Army offers to buy 300 frogs at $6 each. What is the opportunity cost associated with each frog sold to the Army at this price?

Answer 1

1	A sale should occur at a price between $45 and $75. The $77 that you paid for the book is a sunk cost and hence is irrelevant. The price that the bookstore charges for a new copy of the book is also irrelevant. opportunity cost is the $45 that the bookstore will pay you for the book. The other student’s opportunity cost is the $75 that the bookstore charges for a used copy of the book.
2	original manufacturing cost is sunk cost i.e $15
3	A. original manufacturing cost is sunk cost i.e $15
	B. Refit the watches and sell for $18 each, As $18-$4 = 14$ > 20% of original cost of manuf $15 14 > 3
	C. Either $3 (20% of $15) or $11, depending on whether one defines the opportunity cost as the benefit from taking the tax deduction, or the difference between the profit from refitting the watches and the benefit from taking the tax deduction.
4	A Since Jennie Mae is operating at capacity, she should not sell to the Army for less than $9, her usual sales price.
	B. $7 (calculated as $9 – $2) if you define opportunity cost as the profit from the next best alternative, or $3 (calculated either as $9 – $6 or as $7 – $4) if you define opportunity cost as the difference between the profit from selling to the Army and the profit from the next best alternative.
	C Zero, since Jennie Mae has excess capacity.