Randy owns a landscaping business. At the beginning of the season. Randy must de

Question

Randy owns a landscaping business. At the beginning of the season. Randy must decide how many commercial lawn mowers he should purchase. Assume that each additional lawn mower costs 510, 000 and that Randy's investment will be financed by a bank loan. Randy has estimated his rate of return, as shown in the table below. a. If the real interest rate is 6%, how many commercial lawn mowers will Randy buy? lawn mowers b. Using the information in the table, plot the investment demand curve (l_1) for Randy's landscaping business. Instructions: Use the tool provided 'IV to plot the line point by point c. Suppose that unusually bad weather reduces the demand for lawn mowing and therefore the profitability of additional lawn mowers. This forces Randy to re-estimate the rate of return for each lawn mower by 2%. In other words, the new rate of return for the first mower is 8%, the rate of return for the second mower is 7%, and so forth. Using the graph above, plot the new investment demand curve (I_2). Instructions: Use the tool provided to plot the line point by point d. If the real interest rate is 6%, how many commercial lawn mowers will Randy buy now? lawn mowers

Explanation / Answer

In this problem Randy for his business wants to purchase Lawn mpwers. He has to decide optimal number of mowers. Each mower requires an investment of $10,000. For 1st mower, rate of return is 10%. Gradually this rate will drop by 1% with the increase in number of mowers. The equipments are puchaed from bank loan. Real interest rate on loan is 6%. So purchase of a mower is profitable only when the return is more than 6%. Now compare the return percentage specified in the chart. It is 10% for 1st mower, 9% for 2nd, 8% for third one, 7% for 4th one and 5% for 5th one. So he will buy upto 5th land mower.

Answer: 5 land mower.

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b. Investment demand curve indicates relationb between investment and real interest rate on loan. If interest is low, then borowing money for investment will be cheap. So more will be the investment demand. Here an investment demand schedule has been prepared at different interest rates

Based on this schedule Investment demand curve is drawn below:

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Part (c): Due to bad weather rate of return as expected will drop by 2% in each case. So from first mower return is 8% instead of 10%. All other figures are less by 2%. Based on this change the investment schedule is-

So changed investment demand curve is-

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Answer (d) Under changed situation at 6% rate, only 3 mowers will be demanded. So investment demand is $30,000.

Investment schedule Interest rate Demand Investment 10 1 10000 9 2 20000 8 3 30000 7 4 40000 6 5 50000 5 6 60000 4 7 70000

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