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Module 5 : Problems for Practice

Question 5.1:

Apex Ltd is considering expanding its production facility to manufacture an

electrical component. Mr Verma, Production Manager, has been asked to determine how
many; units must be produced and sold in order to break even. The fixed cost for
new equipment and installation is Mu 100,000.Each unit produced has a variable cost
of Mu 12 per unit and sells for Mu 20.

Question 5.2 :

Mr. Sharma borrowed Rs.500,000 from a local financing company. The loan is to be
repaid at the end of 4 years at an interest rate of 14% per year, compounded
annually. How much will Mr. Sharma owe in 4 years? How much will Mr. Sharma owe if
the interest rate is compounded semiannually?

Question 5.3:

An industrial manufacturer wants to investigate the economics of investing in new

machinery for its production plants. The initial cost of this new machinery will be
Rs.95,000, with an estimated life of 20 years. If the equipment is purchased, the
Vice-President of Manufacturing estimates that operating costs for the first 10
years will be reduced by Rs.12,000 per year. For the next 5 years, annual operating
costs will be reduced by Rs. 10,000 per year, and the remaining 5 years operating
costs will be reduced by Rs.5,000 per year. Evaluate the option.

Question 5.4:

A machine needed for 3 years can be purchased for Mu 75,000 and sold at the end of
period at about Mu 25,000. A comparable machine can be leased for Mu 30,000 per
year. If the firm expects 20 % return, should it buy or lease the machine when end-
of-year payments are expected?

Question 5.5

Two models of a small machine perform the same function. Type 1 machine has a low
initial cost of Mu 9,500, relatively high operating costs of Mu 1,900 per year more
than that of Type 2 machine, and a short life of 4 years. The more expensive
machine, Type 2 machine costs Mu 25,000 and can be kept in service economically for
8 years. Which machine would you prefer, if rate of return is 8 %?

Question 5.6

Suppose that a company manufacturing electronic calculators produced 10000

calculators by employing 50 people at 8 hours/day for 25 days. Compute input,
output and productivity. What is the efficiency if the target daily production is
12000 calculators?

Question 5.7

A businessman has two independent investment options A and B available to him, but
he lacks the capital to undertake both of them simultaneously. He can choose to
take A first and then stop, or if A is successful, then take B or vise versa. The
probability of success of A is 0.7, while for B it is 0.4. Both investments require
an initial capital outlay of Mu . 2,000 and both return nothing if the venture is
unsuccessful. Successful completion of A will return Mu. 3,000 (over cost), and
Successful completion of B will return Mu. 5,000 (over cost). Draw decision tree
and determine the best strategy.

Question 5.8

A company owns a lease on a certain property. It may sell the lease for Mu 12,000
or it may drill the said property for oil. Various possible drilling results are as
under along with the probabilities of happening and rupee consequences:

Possible Results Probability Monetary consequences(in Mu)

Dry well 0.10
-1,00,000
Gas well only 0.40 45,000
Oil and gas combination 0.30 98,000
Oil well 0.20 1,99,000

Draw a decision tree diagram for the above problem and calculate EMV for the act
drill. Should the company drill or sell?

Question 5.9

A manager has a choice between (i) A risky contract promising Mu 7 lakhs with
probability 0.6 and Mu. 4 lakhs with probability 0.4 (ii) A diversified portfolio
consisting of two contracts with independent outcomes and each promising Mu. 3.5
lakhs with probability of 0.6 and Mu. 2 lakhs with probability 0.4. Construct a
decision tree for using a EMV criterion. Can you arrive at the decision using EMV
criterion?

Prof.S.G.Deshmukh & Prof.Arun Kanda