4. Tax Incidence: How do the effects of a tax differ between markets with different elasticities of supply? Consider two hypothetical markets. In both cases, the demand function is

QD = 450 -.5P

The two supply functions are

QS1 = .5P - 50

and

QS2 = P - 300

a. Solve for equilibrium price and quantity for both cases and show that the equilibrium values are the same in these two cases (for QS1 and QD and for QS2 and QD). Plot the inverse supply and demand functions (with P as function of Q) for the two markets on the same graph.

b. Now suppose a tax is imposed in both markets, equal to $100 per unit purchased. Model this as a shift in the demand curve (so that QD now depends on P, the net price paid to the firm, plus the tax). Illustrate the new demand curve on your graphs (label everything clearly). Derive the new equilibrium price (the net price received by the firm) and quantity for each of the two cases. In which case is the producer’s share of the tax burden greater?

c. Calculate deadweight loss in each case. In which case is deadweight loss greater?

Price (dollars per gallon) Quantity of demand Quantity supplied

1.00 600 0

1.50 500 200

2.00 400 400

2.50 300 600

3.00 200 800

3.50 100 1,000

4.00 0 1,200

4) The table gives the demand and supply schedules for milk in Cowburg. Assume that the only people who benefit from milk are the people who consume it and the only people who bear the cost of milk are the people who produce it. a) Draw the market demand and market supply curves. What are the equilibrium price and equilibrium quantity of milk? Is this equilibrium efficient? Explain. b) What is the maximum price that consumers are willing to pay for the 500th gallon? What is the minimum price that producers are willing to accept for the 500th gallon? Explain. c) If the market for milk is efficient, what is the consumer surplus? Show it on your graph. What is the producer surplus? Show it on your graph. d) If farmers produce 500 gallons a day, is there a deadweight loss? If yes, what is it? Explain your answer using your graph.

DC Inc. has two production divisions. Division A produces Component X, which is used by Division B. To Division A, the cost of producing one unit of X consists of unit direct material cost of $100, unit direct labor cost of $130, unit variable overhead of $125, and unit fixed overhead of $48 at the current production volume. The current market price of X is $500 per unit. The company is now trying to determine the transfer price of X.

1. Using the general transfer pricing rule, find the market-based transfer price for each of the following scenarios:

1) Division A is operating at full capacity.

2) Division A is operating at less than full capacity.

(4 points)

2. Describe a situation when a market-based transfer price is not likely to work. Explain in detail using dollar amounts. (8 points)

3. Suggest other approaches that may replace the market-based approach. For each of those alternatives, explain in detail using dollar amounts. (8 points)

DC Inc. has two production divisions. Division A produces Component X, which is used by Division B. To Division A, the cost of producing one unit of X consists of unit direct material cost of $100, unit direct labor cost of $130, unit variable overhead of $125, and unit fixed overhead of $48 at the current production volume. The current market price of X is $500 per unit. The company is now trying to determine the transfer price of X.

1. Using the general transfer pricing rule, find the market-based transfer price for each of the following scenarios:

1) Division A is operating at full capacity.

2) Division A is operating at less than full capacity.

(4 points)

2. Describe a situation when a market-based transfer price is not likely to work. Explain in detail using dollar amounts. (8 points)

3. Suggest other approaches that may replace the market-based approach. For each of those alternatives, explain in detail using dollar amounts. (8 points)

DC Inc. has two production divisions. Division A produces Component X, which is used by Division B. To Division A, the cost of producing one unit of X consists of unit direct material cost of $100, unit direct labor cost of $130, unit variable overhead of $125, and unit fixed overhead of $48 at the current production volume. The current market price of X is $500 per unit. The company is now trying to determine the transfer price of X.

1. Using the general transfer pricing rule, find the market-based transfer price for each of the following scenarios:

1) Division A is operating at full capacity.

2) Division A is operating at less than full capacity.

(4 points)

2. Describe a situation when a market-based transfer price is not likely to work. Explain in detail using dollar amounts. (8 points)

3. Suggest other approaches that may replace the market-based approach. For each of those alternatives, explain in detail using dollar amounts. (8 points)

Citron Inc. offers an employee stock option plan (ESOP) to several of its senior executives. 20,000 options were granted on January 1, 20X5, under this plan. The exercise price of the options was $25 per share. They vested two years from the grant date. 100% of the options vested. Citron maintains a separate contributed surplus account for expired options. Other information about the ESOP follow:

On December 31, 20X9, when the unexercised options expired, what amount should have been credited to the contributed surplus — expired stock options account?

Fixed Income: SHORT ANSWER QUESTION

1. You are an investment consultant working for a superannuation firm. One of the fixed-income portfolio managers wants to understand more about managing interest rate risk in the portfolio, and she is particularly interested in understanding the concept of duration. The portfolio currently contains option free bonds but the manager is considering adding bonds with embedded options into the portfolio. The manager is also considering purchasing a three-year 6% annual coupon paying bond. The one-year spot rate is 4%, the two-year spot rate is 3%, and the three-year spot rate is 4%. What is the value of the option free bond that is being considered for purchase? State all formula and working used.

2. The relationship between bond prices and yields is very important to fixed-income investors. Explain the characteristics of a bond that affect its price volatility.            

3.Calculate the convexity adjustment for a bond if the initial price is $104.45, price if yields increase by one percent is $100 and price if yields decrease by one percent is $109.16. Show all formulas used.   

Problem 19-12 Current yield on a convertible bond [LO19-1]

The Olsen Mining Company has been very successful in the last five years. Its $1,000 par value convertible bonds have a conversion ratio of 36. The bonds have a quoted interest rate of 8 percent a year. The firm’s common stock is currently selling for $48.50 per share. The current bond price has a conversion premium of $10 over the conversion value.

a. What is the current price of the bond? (Do not round intermediate calculations and round your final answer to 2 decimal places.)
  

b. What is the current yield on the bond (annual interest divided by the bond’s market price)? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
  

c. If the common stock price goes down to $25.90 and the conversion premium goes up to $100, what will be the new current yield on the bond? (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
  

A bond has a $1,000 par value, 10 years to maturity, and a 8% annual coupon and sells for $980.

1. What is its yield to maturity (YTM)? Round your answer to two decimal places.
   
      %
   
2. Assume that the yield to maturity remains constant for the next 5 years. What will the price be 5 years from today? Do not round intermediate calculations. Round your answer to the nearest cent.

INTEREST RATE SENSITIVITY

An investor purchased the following 5 bonds. Each bond had a par value of $1,000 and an 10% yield to maturity on the purchase day. Immediately after the investor purchased them, interest rates fell, and each then had a new YTM of 7%. What is the percentage change in price for each bond after the decline in interest rates? Fill in the following table. Round your answers to the nearest cent or to two decimal places. Enter all amounts as positive numbers.