#Learning Journal #Economy Activities

Suppose a construction company is trying to decide whether to buy a new nail gun. The table below shows the hypothetical costs for the nail gun and the amount the gun will save the company each year. Assume the gun will last forever. In each case, determine the highest interest rate the company should pay for a loan that makes the purchase of the nail gun possible.

a. The $1,000 cost of the new nail gun in the example given affects a decision to purchase it. We saw that buying the new nail gun makes sense at interest rates below 10% and does not make sense at interest rates above 10%. If the new nail gun costs $1,000, then the interest return on the investment would be 10% (the annual saving of $100 divided by the $1,000 initial cost), and the investment would be undertaken at any interest rate below 10%.

b. Buying the new nail gun makes sense at interest rates below 20% and does not make sense at interest rates above 20%. If the new nail gun costs $1,000, then the interest return on the investment would be 20% (the annual saving of $200 divided by the $1,000 initial cost), and the investment would be undertaken at any interest rate below 20%.

c. If the new nail gun costs $1,000, then the interest return on the investment would be 30% (the annual saving of $300 divided by the $1,000 initial cost), and the investment would be undertaken at any interest rate below 30%.

A car company currently has a capital stock of $100 million and desires a capital stock of $110 million. 

1. If it experiences no depreciation, how much will it need to invest to get to its desired level of capital stock?

To get to its desired level of the capital stock of $110million, with no depreciation, it needs to invest an additional $10 million

$110 - $100 + 0 = $10

2. If its annual depreciation is 5%, how much will it need to invest to get to its desired level?

To get to its desired level of the capital stock of $110million, with 5% of depreciation, it needs to invest an additional $15 million

$110 - $100 + $100*5% = $15

3. If its annual depreciation is 10%, how much will it need to invest to get to its desired level?

To get to its desired level of the capital stock of $110million, with 10% depreciation, it needs to invest an additional $20 million

$110 - $100 + $100*10% = $20

Burger World is contemplating installing an automated ordering system. The ordering system will allow Burger World to permanently replace five employees for an annual (and permanent) cost savings of $100,000.

1. If the automated system costs $1,000,000, what is the rate of return on the investment?

The rate of return on the investment is 10% ( $100,000 / $1,000,000 ), since the automated ordering system will replace five employees for an annual (and permanent) cost savings of $100,000.

2. If the system cost $2,000,000, what would be its rate of return?

The rate of return on the investment is 5% ( $100,000 / $2,000,000 ), if the automated ordering system will replace five employees for an annual (and permanent) cost savings of $100,000.

3. If the government were to introduce an investment tax credit that allows firms to deduct 10% of its investment from its tax liability, what would happen to the rate of return if the system costs $1,000,000?

If an investment tax credit that allows firms to deduct 10% of its investment from its tax liability, then the return on investment will increase by 10%. 

$1,000,000*10% = $100,000 (Return on deduct 10% of its investment from its tax liability)

$100,000 + $100,000 = $200,000 (Total return on investment)

 ( $200,000 / $1,000,000 ) = 20%

The rate of return on the investment might be 20%

4. If Burger World has to pay 8% to borrow the funds to purchase the system, what is the most it should pay for the system? Assume that there is no investment tax credit.

Suppose the system costs $1,000,000 and Burger World has to pay 8% to borrow the funds to purchase the system and the ordering system will allow Burger World to permanently replace five employees for an annual (and permanent) cost savings of $100,000.

The funds which Burger World has to pay to borrow the funds to purchase the system is $1,000,000*8% = $80,000

Since the ordering system will allow Burger World to permanently replace five employees for an annual (and permanent) cost savings of $100,000

The most it should pay for the system should below the profitable line of $100,000