Butters is considering how many snowmobiles to purchase for his snowmobile renta

ID: 1207882 • Letter: B

Question

Butters is considering how many snowmobiles to purchase for his snowmobile rental business. Below are his estimates of the number of snowmobile rentals per year, depending on the number of snowmobiles available. Butters expects to net $10 per rental. Each snowmobile costs $10,000. How many snowmobiles should Butters purchase if the real interest rate is 2% and each snowmobile depreciates at the rate of 3.5% per year? 1 2 3 4 5 In the question above (Butters's snowmobile business), the real User Cost of Capital (marginal cost) for a snowmobile is: $550 per year 55 rentals per year $55 per year $10 per year 550 rentals per year

Explanation / Answer

20.

Correct Answer:

D. 4

Working Note:

Cost of snowmobile per year = Depreciation Cost + opportunity cost of investment

Investment in each snowmobile = $10000

Rental Charge = $10 per rental

Thus,

Following table is prepared to calculate the total cost at different unit purchase of snowmobiles.

No. of Snowmobile

Depreciation cost ($)

Opportunity cost of investment ($)

Total Cost ($)

=10000*3.5% = 350

=10000*2% = 200

=350+200 = 550

=20000*3.5% = 700

=20000*2% = 400

=700+400 = 1100

=30000*3.5% = 1050

=30000*2% = 600

=1050+600 = 1650

=40000*3.5% = 1400

=40000*2% =800

=1400+800 = 2200

=50000*3.5% = 1750

=50000*2% = 1000

=1750+1000 = 2750

Net profit from employing snowmobiles = revenue – Cost

Net profit from employing 1 snowmobile = 90*10 - 550 = $350

Net profit from employing 2 snowmobiles = 170*10 - 1100 = $600

Net profit from employing 3 snowmobiles = 240*10 – 1650 = $750

Net profit from employing 4 snowmobiles = 300*10 – 2200 = $800

Net profit from employing 5 snowmobiles = 350*10 – 2750 = $750

Since, maximum net profit is earned when 4 units of snowmobiles are used, thus Butters should purchase 4 snowmobiles.