Smart Bumpkins Wants to Increase Production by Adding New Equipment

question 29

Multiple Choice

Smart Bumpkins wants to increase production by adding new equipment. The cost of the upgrade is $190,000, and expected cash flows from the new upgrade are expected to be as follows over the next 6 years, and the risk-free rate is 5%. Should the company upgrade? ? $$\begin{array} { | l | l | } \hline \text { Cash Flows } & \text { Certainty Equivalents } \\\hline \$ 45,000 & 0.85 \\\hline \$ 45,000 & 0.80 \\\hline \$ 75,000 & 0.75 \\\hline 110,000 & 0.70 \\\hline \$ 110,000 & 0.60 \\\hline 110,000 & 0.50 \\\hline\end{array}$$

• A) Yes, the CNPV is $195,196.06.
• B) Yes, the CNPV is $83,775.16.
• C) No, the CNPV is -$75,522.84.
• D) No, the CNPV is -$42,175.93.

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Definitions:

Short Run

A time period in which at least one input, typically capital, is fixed, affecting the firm's capacity to adjust to changes in demand or production.

Producing

The act of creating, manufacturing, or otherwise bringing into existence goods or services to be offered for consumption or use by others.

ATC

Average Total Cost; the sum of all production costs divided by the quantity of output, representing the cost per unit including both fixed and variable costs.

Monopoly Power

The exclusive ability of a company to determine the price and production level of a product or service in the market.