IMSE3115 Practice Problems I - Solution

October 21, 2024

Questions:

1. Stan Moneymaker presently owns a 10-year-old automobile with low mileage (78,000 miles). The
NADA “blue book” value of the car is $2,500. Unfortunately, the car’s transmission just failed,
and Stan decided to spend $1,500 to have it repaired. Now, six months later, Stan has decided to
sell the car, and he reasons that his asking price should be $2, 500 + $1, 500 = $4, 000. Comment on
the wisdom of Stan’s logic. If he receives an offer for $3,000, should he accept it? Explain your
reasoning.
Answer:
Stan’s asking price of $4,000 is probably too high because the new transmission adds little value to
the N.A.D.A. estimate of the car’s worth. (Low mileage is a typical consideration that may inflate
the N.A.D.A. estimate.) If Stan can get $3,000 for his car, he should accept this offer. Then the
$4,000 - $3,000 = $1,000 “loss” on his car is a sunk cost.
2. The fixed and variable costs for three manufacturing plant sites for a product are shown in the
following table:

Site Fixed Cost per Year Variable Cost per Unit

A $500 $10
B $1,000 $8
C $1,500 $6

a. Over what range of production is each location optimal?

b. Which site is best for the production of 200 units?
Answer:
a. Let x be the units of manufactured products. Because

500 + 10x ≤ 1000 + 8x ⇒ x ≤ 250 ⇒ when x ≤ 250, A is better than B

500 + 10x ≤ 1500 + 6x ⇒ x ≤ 250 ⇒ when x ≤ 250, A is better than C
1500 + 6x ≤ 500 + 10x ⇒ x ≥ 250 ⇒ when x ≥ 250, C is better than A
1500 + 6x ≤ 1000 + 8x ⇒ x ≥ 250 ⇒ when x ≥ 250, C is better than B,

we know when 0 ≤ x ≤ 250, site A is the optimal, while when x ≥ 250, site C is the optimal.
b. Because 200 ≤ 250, site A is the optimal.
3. A company produces and sells a consumer product and is able to control the demand for the
product by varying the selling price. The approximate relationship between price and demand is
2, 700 5, 000
p = $38 + − , for D > 1,
D D2
where p is the price per unit in dollars and D is the demand per month. The company is seeking
to maximize its profit. The fixed cost is $1,000 per month and the variable cost (cv ) is $40 per
unit.
 a. What is the number of units that should be produced and sold each month to maximize profit?
b. Show that your answer to (a) maximizes profit.
Answer:
a.
2, 700 5, 000
Profit = (38 + − ) D − 1000 − 40D
D D2
5000
= 38D + 2700 − − 1000 − 40D
D
5000
= −2D − + 1700.
D
d(Profit) 5000
= −2 + 2 = 0 ⇒ D2 = 2500 ⇒ D∗ = 50.
dD D
b.
d2 (Profit) −10000
= < 0 for D > 0.
dD2 D3
So D∗ = 50 is indeed the optimal.
4. A manufacturing concern’s total cost function is C = X/5 and its revenue function is R =
39 log(8X + 1). Find the optimum output where the profit is maximized and the maximum profit.
Answer:

π = R − C = 39 log(8X + 1) − X/5.
dπ
= 39 × 8/(8X + 1) − 1/5 = 0 ⇒ 8X + 1 = 5 × 39 × 8 = 1560 ⇒ X ∗ = 194.875 ≈ 195.
dX
π ∗ = log(8 × 195 + 1) − 195/5 = 85.54.

5. A hot water leak in one of the faucets of your apartment can be very wasteful. A Continuous leak
of one quart per hour at 155○ F causes a loss of 1.75 million Btu per year. Suppose your water is
heated with electricity.
a. How many pounds of coal delivered to your electric utility does this leak equate to if one
pound of coal contains 12,000 Btu and the boiler combustion process and water distribution
system have an overall efficiency of 30%.
b. If a pound of coal produces 1.83 pounds of CO2 during the combustion process, how much
extra carbon dioxide does the leaky faucet produce in a year?
Answer:
(a)
1750000/12000
Loss = = 486(lbs of coal).
0.3
(b) 486 pounds of coal produces 486 × 1.83 = 889 pounds of CO2 in a year.
6. A machine installed five years back for $12,000 is required to be replaced. What is the cost of
replacements, based on the following equipment cost index?

Year Index Year Index

1 200 4 270
2 225 5 285
3 245

Answer:
C5 = C1 × I5 /I1 = 12000 × 285/200 = 17100.
 7. Prepare a composite (weighted) index for housing construction costs in 2008, using the following
data:

Type of Housing Percent Reference Year (I = 100) 2008

Single units 70 41 $/ft2 62 $/ft2
Duplex units 5 38 $/ft2 57 $/ft2
Multiple 25 33 $/ft2 53 $/ft2

Answer:
0.7(62/41) + 0.05(57/38) + 0.25(53/33)
I2014 = × 100 = 153.5.
0.7 + 0.05 + 0.25
8. A railways engineering company plans to start a new metro rail line. It requires electric poles
and cables to supply power. It is estimated that 40 km of cabling will be needed and that each
km of cabling costs $10,000 (including labor). An electric pole is to be installed every 60 meters
on average, and the cost of the pole and installation is $2000. What is the estimated cost of the
entire job?
Answer:

C = 40 × 10000 + ⌈(40 × 1000)/60⌉ × 2000 = 40 × 10000 + 667 × 2000 = 1734000.

9. In a learning curve application, 846.2 work-hours are required for the third production unit and
783.0 work-hours are required for the fifth production unit. Determine the value of n and s in

Zu = K(un ).

Answer:

Z3 = 846.2 = K(3)n and Z5 = 783 = K(5)n .

So
846.2 3 n
= ( ) ⇒ log(1.0807) = n log(3/5) ⇒ n = −0.1519.
783 5
log s
= −0.1519 ⇒ log s = −0.1519 × log 2 ⇒ s = 0.9.
log 2

10. The cost of building a supermarket is related to the total area of the building. Data for the last
10 supermarkets built for Regork, Inc., are shown in the accompanying table.

Building Area (ft2 ) Cost($)

1 14,500 800,000
2 15,000 825,000
3 17,000 875,000
4 18,500 972,000
5 20,400 1,074,000
6 21,000 1,250,000
7 25,000 1,307,000
8 26,750 1,534,000
9 28,000 1,475,500
10 30,000 1,525,000

Develop a CER for the construction of supermarkets. Use the CER to estimate the cost of Regork’s
next store, which has a planned area of 23,000 square feet.
Answer:
11. Rick wants to have earned $10,000 at the end of 6 years. How much must he deposit today in
order to do so, if his rate of interest is fixed at 8% compounded annually?
Answer:
P = $10, 000(P /F, 8%, 6) = $10, 000 × 0.6302 = 6, 302.
12. A student’s average tuition fee is $1,000 per year over 20 years of student life. Find the total fees
the student would pay at the end of 20 years, if the interest rate is 5% compounded annually.
Answer:
F = $1, 000(F /A, 5%, 20) = $1, 000 × 33.0660 = 33066.
13. Luis wants to have $2,000,000 in net worth when he retires. To achieve this goal, he plans to
invest $10,000 each year (starting one year from now) into an account that earns 10% interest
compounded annually. The amount of time before Luis can retire as a multi-millionaire is how
many years?
Answer:
2, 000, 000 = 10, 000(F /A, 10%, n) ⇒ (F /A, 10%, n) = 200.
From the factor table, we know that (F /A, 10%, 30) = 164.4940 and (F /A, 10%, 35) = 271.0244.
Using the interpolation, we obtain
n − 30 200 − 164.4940 200 − 164.4940
= ⇒n= × 5 + 30 ≈ 31.6664.
35 − 30 271.0244 − 164.4940 271.0244 − 164.4940

14. A series of 10 annual payments of $8,000 is equivalent to four equal payments at the end of years
6, 10, 12, and 15 when the interest rate is 10% compounded annually. What is the amount of
these four payments?
Answer:
8000(P /A, 10%, 10) = x((P /F, 10%, 6) + (P /F, 10%, 10) + (P /F, 10%, 12) + (P /F, 10%, 15))
8000 × 6.1446 = x(0.5645 + 0.3855 + 0.3186 + 0.2394)
x = 32, 597.35.
15. Show that the following relationship is true: (A/P, i%, N ) = i/[1 − (P /F, i%, N )].
Answer:
i(1 + i)N i i
(A/P, i%, N ) = = = .
(1 + i) − 1 1 − 1/(1 + i)
N N 1 − (P /F, i%, N )