Question 1 (value of decision options, opportunity cost, sunk costs).
You inherited a house in San Diego from a rich uncle. You need money now, so you are considering three options:
* option A: sell the house for $310,000
* option B: spend $75,000 on improving the house, after that sell it for $380,000.
* option C: burn the house for insurance money. The house is insured for $216,000.
Not selling the house is not a viable option.
If you sell the house (options A and B), you will have to pay realtor's fees and taxes, which amount to 8% of the selling price. (For example, if you sold the house for $100,000, the total cost of fees and taxes will be $100,000*0.08=$8,000).
If you burn the house, you'll have to hire a good lawyer to prove it was an accident. The lawyer will cost you $21,000 (you do not have to pay realtor's fees and taxes in this case).
Required:
a) What is the value of each option?
A= B= C=
b) Which option should you choose?
(enter 1 for A, 2 for B, 3 for C)
c) What is the opportunity cost of options A and B?
A= B=
d) Suppose you bought the house for $500,000 in 2007, instead of getting it from a rich uncle for free (the rest of the numbers do not change). Should you choose option A, B or C in this case?
(enter 1 for A, 2 for B, 3 for C)
e) If you got different answers in (b) and (d), explain why they are different. If you got the same answers in (b) and (d), explain why they should be the same.
Question 2 (fixed/mixed/variable costs)
Generic Motors incurs three types of costs (a, b and c) in its manufacturing process. The following table presents total costs for each type for two different activity levels:
|
(a)
|
(b)
|
(c)
|
|
5,000 units
|
$50,000
|
$15,000
|
$45,000
|
|
7,500 units
|
$75,000
|
$17,500
|
$45,000
|
Required:
Identify whether each cost is fixed, mixed or variable?
Cost a =
fixed variable mixed
Cost b =
mixed fixed variable
Cost c =
fixed variable mixed