Problem 1 - Concepts Explain the concepts of fixed cost versus variable cost. Al

Question

Problem 1 - Concepts

Explain the concepts of fixed cost versus variable cost. Also contrast the concept of fixed cost to sunk cost.

Explain what “interest” is (in the financial sense). Briefly discuss the main reasons for interest being widely accepted and used in the modern economy.

Explain the concept of “capitalized worth”, relating it to the economic concept of “rent”.

Explain the “internal rate of return” by relating it to the PW of a project and the MARR. Also discuss its advantages as a decision metric and its shortcomings

Explanation / Answer

Fixed cost is the cost that remain fixed upto a certain level of activity. Variable cost is the cost that varies with the each unit of additional output.

Sunk cost is the cost that has been spent alreay and it will not affect the decision making for taking up the new orders and is irrelavent

interest is the return for the use of money. it is cost for usage for time value of money.

the rent if capitalised/ discounted for the time at the cost of caital will give capitalised worth.

IRR is the rate of return at which the NPV is Zero.

MARR is the minimum rate that should be attained from investing in the project which may be the oppurtunity cost of capital.

Advantages:

Easy to compare the projects

Disadvantages: tidious calcuations are required.

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