Lucy is contemplating opening her own custom saddle factory. She estimates that
ID: 2751601 • Letter: L
Question
Lucy is contemplating opening her own custom saddle factory. She estimates that she can make 10 saddles per year and sell them for $15,000 each. The raw materials to make 10 saddles would cost $70,000. Lucy has $100,000 saved but she would need to borrow an additional $100,000 at 10% interest to be able to open her factory (assume that Lucy could loan out her money at 10%, too). Lucy could, instead, work in an established competitor’s saddle factory and earn $50,000 per year.
What is Lucy’s annual opportunity cost if she decides not to open her own saddle factory and instead decides to go to work in the competitor’s established factory?
Explanation / Answer
IF GOES WITH THE DECESSION OF OWN FACTORY
SELL PRICE OF THE SADDLES ($15000 * 10) = $150000
LESS- RAW MATERIAL COST =($70000)
LESS- INTEREST ON BORROWING@10% =($10000)
LESS- INTEREST ON OWN SAVINGS FORGONE@10% =($10000)
TOTAL PROFIT FROM FACTORY OPERATION =$60000
IF GOES WITH DECESSION OF WORK IN COMPETITOR'S FACTORY
SALARY FOR THE YEAR =$50000
ADD- INTEREST ON OWN SAVINGS EARNED @10% =$10000
ADD- SAVING OF INTEREST COST DUE TO FOREGOING THE OTHER OPPERTUNITY =$10000
TOTAL PROFIT BY WORKING ON COMPITITIORS FACTORY =$70000
OPPERTUNITY COST BY WORKING IN COMPITITORS FACTORY = $70000 - $60000
= $10000
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