CHAPTER 1
The Fundamentals of
Managerial Economics
McGraw-Hill/Irwin
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter One
Chapter Overview
• Introduction
– The manager
– Economics
– Managerial economics defined
• Economics of Effective Management
– Identifying goals and constraints
– Recognize the nature and importance of profits
– Understand incentives
– Understand markets
– Recognize the time value of money
– Use marginal analysis
• Learning managerial economics
1-2
Introduction
Economics
• The science of making decisions in the presence of scarce resources.
– Resources are anything used to produce a good or service, or achieve a goal.
– Decisions are important because scarcity implies
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– Consumer-consumer rivalry.
– Producer-producer rivalry.
• Government and the market.
1-14
Economics of Effective Management
The Time Value of Money
• Often a gap exists between the time when costs are borne and benefits received.
– Managers can use present value analysis to properly account for the timing of receipts and expenditures. 1-15
Economics of Effective Management
Present Value Analysis 1
• Present value of a single future value
– The amount that would have to be invested today at the prevailing interest rate to generate the given future value:
– Present value reflects the difference between the future value and the opportunity cost of waiting:
1-16
Economics of Effective Management
Present Value Analysis II
• Present value of a stream of future values or, 1-17
Economics of Effective Management
The Time Value of Money in Action
• Consider a project that returns the following income stream:
– Year 1, $10,000; Year 2, $50,000; and Year 3,
$100,000.
– At an annual interest rate of 3 percent, what is the present value of this income stream?
1-18
Economics of Effective Management
Net Present Value
• The present value of the income stream generated by a project minus the current cost of the project:
1-19
Economics of Effective Management
Marginal Analysis
• Given a control variable, , of a managerial objective, denote the
– total
10. What is the net present value (NPV) of a long-term investment project? Describe how managers use NPVs when evaluating capital budget proposals.
In the beginning, there was no real stock market. However stock exchanges did take place in smaller groups and corporations. This all took place during the 1700's where stocks were already around for a long time before that but it wasn't really popular in the United States. Stocks originally started as auctions where traders called out names of companies and the shares available. There was a auction that took place and the shares went to the highest bidders.
The stock market has always intrigued me and I have since been eager to learn more about it. Starting back in January of this year, I ordered three textbooks on stock trading to become more informed on the subject. After reading these books, I gained further insight on stock trading which led me to open my own brokerage account where I could buy and sell stocks. I started by playing a stock simulation which was very similar in concept to StockTrak, a program we used in this class. I found that this helped provide me with a hands on experience which helped familiarize me with stock trading and learning how to manage and use my money efficiently. I continued to play this simulation for about two months and during this time my portfolio grew about 4%, which provided me a confidence boost and motivated me to invest in my real money into the stock market. In March of 2015, I officially began trading in the stock market and I continued to learn along the way. As of now, I have roughly nine months of stock trading experience. As stated previously, I have always had in interest in the stock market, but I never acted upon it until as recently as earlier this year. My interest in the stock market was peaked because I enjoy taking risks and the stock market
EEC calculated the amount of time involved the anticipation of its cost ($3 million). The timeline in recovering their cost of investment ($2 million) initially for the foundation of this investment any profit made in the future of this investment will be justified as a profit for the company. If EEC can anticipate a fast return on its investment it is a profitable wise decision in making the investment financial, it is considered to be an easier way of formulating investments financially. On the basis of one year all cash flows is added together equal to the sum of $2 million originally invested, then it is divided by the annual cash flow of $500,000. The calculation of the payback period would equal four years. After this time frame any financial proceeds will be considered profitable for the company. I conclude that the timeframe is adequate in comparison of the investment in this worthwhile investment financial venture for the company.
Discounting a project at a reasonable rate, takes charge of the possible depreciation of the project value in the future. Estimated returns on a project can dwindle for so many reasons such as market fluctuations, price changes, technological innovations, depreciation in the value of money. Even the fixed assets of production are subject to the law of diminishing returns. A pipeline value can be fixed but that value depreciates over time due to ageing, wear
For the month of December, I was given an assignment consisting of $100,000 and four stocks to invest in. My four stocks were The Ralph Lauren Corp., Visa Inc., Master card Inc. and The Chevron Corp. As stated I was given a month to record my data and I ended up with a total capital gain of $5,518.36 for the one month period for my investments. I have to thank you Mr. Acker, this project was not difficult, but it did confuse me. Receiving this assignment scared me in a way, because I didn’t know what I was getting into. The finance world is scary and tricky, one minute the market is doing good and other days it would be low. While calculating my capital gains or losses I thought I would lose a larger
In oligopoly market, each firm has substantial market power with high degree of interdependence. The key for success in a oligopoly market is to gain more market share than the competitors. Increasing the price can lead to loss of market share to the competitors, so in the oligopoly market, if a firm decreases the price, the other firms will always follow, but if a firm increase the price, the other firms will not follow. The demand curve is kinked.
The Super Project presented General Foods management with the possibility to introduce a new dessert product, named Super, into the market. The dilemma management faced was how to appropriately measure and allocate costs associated with the project, as well as, whether to accept or reject the project based on costs and future cash flows generated by Super. With regard to The Super Project or any capital budgeting decision, time value of money concepts are central to financial
In fully investigating all of our calculations we are fully invested in using the Net Present Value figures we calculated as a means of ranking the eight projects. In doing so we found reasons in which why the Net Present Value was our benchmark for ranking the projects and why we did not use the Payback Method. The Payback Method ignores the time value of money, requires and arbitrary cutoff point, ignores cash flows beyond the cutoff date, and is biased against long-term projects, such as research and development and new projects. When comparing the Average Accounting Return Method to the Net Present Value method we found that the Average Accounting Return Method is a worse option than using the Payback Method. The Average Accounting Return Method is not a true rate of return and the time value of money is ignored, it uses an arbitrary benchmark cutoff rate, and is based on accounting net income and book values, not cash flows and market values. Plain and simply put, the Net Present Value method is the best criterion to use when ranking these eight
The discount rate is a means of calculating a value now of benefits that occur in the future. The discount rate recognizes the time value of money. A four percent real discount rate is used in the calculations. However, the high-speed train project would be economically feasible even under the higher discount rates used by some public agencies and economists. The Internal Rate of Return (IRR) is an evaluation measure that is
The efficient market, as one of the pillars of neoclassical finance, asserts that financial markets are efficient on information. The efficient market hypothesis suggests that there is no trading system based on currently available information that could be expected to generate excess risk-adjusted returns consistently as this information is already reflected in current prices. However, EMH has been the most controversial subject of research in the fields of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences in order to
The Net Present Value is one of the techniques that are used by firms when evaluating which investment proposals to take on board and which ones to reject. The net present value is calculated by discounting all flows to the present and subtracting the present value of all inflows.
This project evaluates the discounted Net Present Value which shows the estimated cash flow. The cash flow forecast is for 10 year which incorporates International complexities as well as the cost of capital.
Normal Profit occurs when the average revenue is equal to the average total cost. Abnormal profit is therefore defined as extra profit above normal profit. In the long run, oligopolies make abnormal profits, due to the assumption of high barriers to entry. When firms in an industry seem to be making abnormal profit, it may attract new entrants into the market; causing an increase in supply and therefore a decrease in price leading to normal profits. However since there are high barriers to entry in an oligopolistic market, an influx of new firms into the market is highly unlikely, therefore abnormal profits are sustained in the long run.
The following paper analyzes a project from financial perspectives using the capital budgeting techniques like Net Present Value (NPV) and Internal Rate of Return (IRR).