A firm is considering two potential investments: Option A costs an initial $2 mi

Question

A firm is considering two potential investments:
Option A costs an initial $2 million and will involve constant marginal cost of $5.
Option B costs an initial $4 million and will involve constant marginal cost of $3.
Assume the annual cost of capital is 10% of the total investment( this represents annual fixed cost of the initial investment). At what production quantity per year would the brewery be indifferent between the two investment opportunities?
Answer
a.
20,000 units
b.
200,000 units
c.
150,000 units
d.
100,000 units

Explanation / Answer

A firm is considering two potential investments:
Option A costs an initial $2 million and will involve constant marginal cost of $5.
Option B costs an initial $4 million and will involve constant marginal cost of $3.
Assume the annual cost of capital is 10% of the total investment( this represents annual fixed cost of the initial investment). At what production quantity per year would the brewery be indifferent between the two investment opportunities?
Answer
a. 20,000 units

$2 million x $5=10 x10% =1 million units

$4 million x $3=12 x10% =1.2 million units

1.2 million units - 1 million units =20,000 units

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