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Start working on Chapter One Homework Numbers 10, 12 and 17

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Managerial Economics & Business Strategy Chapter 1 The Fundamentals of Managerial Economics

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Present Value of a Series What if you are “promised” different amounts every year?? Present value of a stream of future amounts (FV t ) received at the end of each period for “n” periods:

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Net Present Value Suppose a manager can purchase a stream of future receipts (FV t ) by spending “C 0 ” dollars today. The NPV of such a decision is n PV – Costs of the project Decision Rule: If NPV < 0: Reject project NPV > 0: Accept project

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What is the maximum we would pay? (number 2) What is the maximum amount you would pay for an asset that generates an income of $150,000 at the end of each of five years if the opportunity cost of using the funds is 9 percent?

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Can we do it?? Buzz-Dot-Com is trying to decide whether or not to purchase a new flying device that will cost them $200,000 and will be “good” for five years. The device will reduce costs by $40,000 the first year, $50,000 the second year, $65,000 the third year, and $80,000 the fourth and fifth years. What is the PV of cost savings if the interest rate is 8%. Should Buzz-Dot-Com purchase the device?

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Can we??

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Present Value of a Perpetuity An asset that perpetually generates a stream of cash flows (CF) at the end of each period is called a perpetuity. If cash flow IS THE SAME EACH YEAR such as certain bonds or stocks….

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Can we do it? (number 5) What is the value of a preferred stock that pays a perpetual dividend of $75 at the end of each year when the interest rate is 4%?

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How much is a firm worth?? The value of a firm equals the present value of current and future profits So maximization of profits really means… n Maximize firm value Which means….Maximize present value of current and future profits

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Goal: Compare BENEFITS of the project to the COSTS Control Variables n Output n Price n Product Quality n Advertising n R&D Basic Managerial Question: How much of the control variable should be used to maximize net benefits? Marginal (Incremental) Analysis

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Net Benefits Net Benefits = Total Benefits - Total Costs Profits = Revenue - Costs

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Marginal Benefit (MB) Change in total benefits arising from a change in the control variable, Q: Slope (first derivative) of the total benefit curve.

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Marginal Cost (MC) Change in total costs arising from a change in the control variable, Q: Slope (first derivative) of the total cost curve

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