IE 3301

Summer 10
Practice Exam 1

Problem 1-2

The accounting department of a large credit card company has assembled the following data for its “Call
Center” as it is considering outsourcing this function. Currently 10,000 square feet of space is rented at $5 per
square foot. Over 200 employees at a monthly pay of $16,000 are currently working. Utilities cost including
telephone cost about $10,000 a month. Overhead cost is about 30% of the cost of labor per year.
An outsourcing company has quoted a price of $4,500,000/ year for this operation for the next five years. Is it
better to outsource this function from an economic perspective?

Solution:

Current operational cost per year:

Rent al expenses = 10,000 (5)(12) = $ 600,000
Utilities = 10,000 (12) = $ 120,000
Labor cost = 16,000 (200)= $ 3,200,000
Overhead expenses = 0.30 (3,200,000) = $ 960,000
Total = $4,880,000
Outsourcing cost /year = $450,000
It is cheaper to outsource.

Problem 1-3

The Amazon Transit Authority in Los Angeles is considering the type of engine to purchase for its next bus
fleet. The outlook for the transit market has been gloomy nation-wide and even worse for the city of Los
Angeles. Currently, the city's bus fleet is equipped with buses using gasoline V-8, 370 cu. in. engines with
manual transmissions and with buses using diesel V-8, and 8.2-liter engines with automatic transmissions. Each
bus has a service life of ten years. The Transit Authority has maintained yearly records of the cost of operations
and repairs for each type of bus in its fleet, and the information is furnished below. You have been hired as an
engineering consultant to perform an economic analysis. Use the following information to identify the type of
engine, gasoline or diesel that is more economical for the Transit Authority bus line. Please indicate the reason
for your choice.

Bus Operating Costs

Gasoline Engines Diesel Engines
Year Operating Costs Miles Driven Operating Costs Miles Driven
1998 $3,565 8,969 $2,906 11,919
1999 2,428 5,206 2,876 10,830
2000 2,352 2,784 2,876 15,612
2001 6,307 3,309 4,784 9,296
Totals $14,652 20,268 $14,442 47,657
Solution:

Gasoline Engines: Cost per mile = $14,652 / 20,268 = $0.7229 per mile.
Diesel Engines: Cost per mile = $ 14,442 / 47,657 = $0.3030 per mile.
Savings using diesel engines = $ 0.7229 - $0.3030 = $0.4199/mile
The Transit Authority should consider buying buses with diesel engines, as it is cheaper to operate them.

Problem 1-7

AT MKBK Plastics Inc, an injection molded parts has been estimated to be $1.05 a piece. ( $0.80 for material
and $0.25 for labor). A tooling expenditure of $50,000 has been incurred to make 5 million parts over a period
of 12 months. After delivering 2 million pieces, it has been found that a better material at a reduced price $0.70
a piece has come to the market. However, the new material requires some modification to the existing tooling.
How much the company can afford to spend on this modification to make cost savings of at least $100,000 on
the contract. Note that, it will delay the delivery and the cost of the delay is estimated to be $150,000.

Solution:

Material Cost Savings on the remaining 3 million parts = (0.80 - 0.70) × 3,000,000
= $300,000
Max expenditure that can be made on the tooling}
modification } =$300,000-150,000 - 100,000
= $50,000

Problem 2-6

Ross Recreations Company, LLC operates a summer camp in Monterey, Tennessee. The following cost data for
a 12-week summer camp is as below.
Charge per camper =$400/week
Variable cost per camper =$220/week
Fixed costs =$240,000 per summer season
Capacity per week =200 campers
Determine
(a). the total number of campers to breakeven for the season.
(b). the profit if the camp is operated at 90% capacity.
(c) the additional profit that can be made if a discount of $100 per week is given for another 10 campers.
Solution:

(a) To breakeven, Total costs = Total revenue

240,000 + 220 (12) X = 400 (12) X
X. = 240,000/ {(400-220)(12)}=111 campers.
(b). 90% capacity
Number of campers = 0.90 (200) = 180
Profit = 180 (400) 12 – {240,000 + 180(12)(220) = $188,800
(c) Additional profit = 10(12)(400-100)- 10(12)(220) = $9,600
Problem 2-12

Kal Tech Engineering Inc. makes a consumer product for which the following three different alternative
production equipment are considered. The demand is expected to be as high as 30,000 units/year.
Determine the ranges of production (units produced per year) over which each alternative is preferable.
Alternative Fixed Costs/ Year Variable Costs/ Unit
A $100,000 $20
B 200,000 5
C 150,000 7.50
Solution:

The breakeven chart is shown below. The analysis is below the chart.

400000
350000
300000
250000 A
Costs, $

200000 B
150000 C
100000
50000
0
0 5000 10000 15000 20000 25000 30000
Units

A and B
100,000 + 20 X = 200,000 + 5 X
X = 6,667
B and C
200,000 + 5 X = 150,000 + 7.5 X
X = 20,000
A and C
100,000 + 20 X = 150,000 + 7.5 X
X = 4,000
For X ≤ 4,000 use Alt. A
For X ≤ 20,000 use Alt. C
For X > 20,000 Alt .B is preferable.

Problem 2-13

Estimate the unit selling price of an item for which the following data is available.
Labor = 16.8 hours at $15.87/hour
Factory overhead = 150% of labor
Material costs = $50.10
Packing cost = 10% of labor
Subcontract cost = $10.20
 Sales commission = 10% of selling price
Profit = 20% of selling price

Solution:
Labor Cost = 16.8 x 15.87 = $266.62
Factory overhead = 150% of labor = 399.93
Material cost = = 50.10
Packing Cost = 10% of labor = 26.66
Subcontract cost = = 10.20
753.51
Let X be the selling price
0.10 X + 0.20 X + 753.51 = X
0.7 X = 753.51
X = 753.51/0.70 = $1,076.44

Problem 3-1

Diana borrowed $3,000 from Pat and promised to pay him $3,405 after 1.5 years. What simple interest rate did
she have in mind?

Solution:
P = $3,000. F = $3,405. N = 1.5 Years.
Interest Earned = F - P = $3,405 - $ 3,000 = $405.
For simple interest rate, interest earned = P × i × n. 405 = 3,000 × i × 1.5.
i= 405 / 4,500 = 0.09 = 9% per year.

Problem 3-3

How long does it take double an investment of $10,000 if the investment pays only simple interest at the rate of
12% per annum?

Solution:

P = $10,000 F = $20,000 i =12%

n =?
20,000 = 10,000 +{10,000 ×(0.12) × n}
n = 10,000 /{(10,000) ×(0.12)}= 8.33 years.

Problem 3-5

How much would you need to invest at 6% interest on December 31, 2002, in order to accumulate $1850 on
December 31, 2009? Present the economic functions required, showing first the functional notation and then
its numerical value.

Solution:

F = $1,850. n = 12/2002 To 12/2009 = 7 Years. i = 6%.

P = F (P/F, i, n) = $1,850 (0.6651) = $ 1,230.44

Problem 3-6

What is the equivalent worth on December 31, 2002, of $1,295 deposited on December 31, 1995? Use an
interest rate of 6%.
Present the economic equivalence function required, showing first the functional notation and then its numerical
value.

Solution:

P = $1,295. n = 12/1995 To 12/2002 = 7 Years. i = 6%.

F = P (F/P, i, n) = 1,295 (F/P, 6%, 7) = 1,295 (1.504) = $1,947.68.

Problem 3-11

Linda inherited a sum of $50,000 from one or her great parents. She would like to invest in one of the following
three possible investment opportunities for a period of 10 years. Choose the best one for her.
i. 9% compounded quarterly.
ii. 8.90% compounded daily.
iii. 8.95% compounded monthly.

Solution:

9% Compounded quarterly
F = $50,000 (F/P, 2.25%, 40) = $121,759.45
8.90% Compounded daily
F = $50,000 {F/P, (8.9/365)%, 3650) = $121,743.28
8.95% Compounded monthly
F = $50,000 {F/P, (8.95/12)%, 120) = $121,961.07
Choose to invest on 8.95% monthly compounding.

Problem 3-14

Tom Weavers is anxious to have his inheritance $10,000 doubled in 5 years. What interest rate should he get if
the interest rate is compounded monthly?

Solution:

P= $10,0000 F= $20,000 n = 60 periods (monthly)

$20,000 = $10,000 (F/P, i%, 60)
(F/P, i%, 60) = 20,000 /10,000 = 2
i (F/P, i%, 60)
1% 1.817
1.25% 2.107
Need to interpolate.
i% = 1 + (2.0 -1.817) * 0.25 / (2.107 - 1.817)
= 1.158%
Yearly or Nominal interest rate = 1.158 x 12 % = 13.896%
Problem 3-20

A piece of equipment that will cost $200,000 ten years from now, what it will cost five years from now if
money is worth 12%.

Solution:

F5 = 200,000 (P/F, 12%, 5) = 200,000 (0.8227) = $164,540

Problem 4-2

Given the cash flow diagram below, compute the value of P.

500

00 2 10 20
4

200000 i = 9%
00
P=?

Solution:

P = 500(P/F, 9%, 20) –200(P/F, 9%, 10) = 500 (0.1784) – 200(0.4224) =$4.72

Problem 4-4

A person has a $350 monthly car payment, which is based on 12% annual interest, compounded monthly.
i. Determine the amount of car bought if it was financed for 60 months and a down payment of $3,00o
was paid.
ii. If he has already made 30 payments and determine, how much will it take to pay off the entire
balance at the time the 31st payment is due?

Solution:
i. The amount of car bought = 350 (P/A, 1%, 60) +3,000 = 350(44.955)+3,000 = $18,734.25
ii. Payoff amount at the time 31st payment = 350 + 350 (P/A, 1%, 29) = 350 + 350 925.066)
= $9,123.10

Problem 4-8

Mary Smith took a car loan of $12,000 to pay back in 60 monthly installments at a nominal interest rate of 12%
on the understanding that the interest rate may be changed sometime in the future. Compute
i. the monthly payment for Mary.
ii. the loan balance immediately after the 24th payment.
ii. the monthly payment for the remainder of the loan if the interest rate is reduced to 9%.

Solution:
i. Nominal interest rate = 12%
i Monthly interest rate = 12%/12 = 1%
Monthly payment at 1% int. per month, A1 = $12,000 (A/P, 1%, 60) = $266.4
ii. After the 24th payment, there will be 36 more payments before the loan is retired. Therefore, loan
balance after the 24th payment = $266.40(P/A, 1%, = $ 8,020.50
iii. Since the nominal interest rate is 9%, monthly interest rate = 9%/12 = 3/4%
Monthly payment at 3/4% int. per month, A2 = $8,020.50 (A/P, 3/4%, 36) = $255.05

Problem 4-11

Given the cash flow diagram below, determine the unknown value using an interest rate of 9%.

600 600
400 400
200 200

0
1 2 3 4 5 6 7

A=?
Solution:

First find the present worth of all the positive cash flows and then find an equivalent uniform amount.
P = 600(P/A, 9%, 3) –200(P/G, 9%, 3) + {200 (P/A, 9%, 3) + 200 (P/G, 9%, 3)}(P/F, 9%, 4)
= 600(2.531) –200(2.386) + {200 (2.531) + 200 (2.386)}(0.7084)
= $1,738.04
A = 1,738.04(A/P, 9%, 7) = 1,738.04(0.1987) = $345.35

Problem 4-13

Your family is expanding in number, and so you decide to sell your current home and to upgrade to a larger
home. You estimate that you can sell your current home for $100,000 and can buy a larger home for
$175,000. You plan to use the entire $100,000 home sale proceeds as a down payment on the new home
and will finance the remainder for 10 years at 6% nominal annual interest compounded monthly. What is
your estimated monthly mortgage payment?

Solution:

Loan amount = 175,000 – 100,000 = $75,000

Monthly interest rate = 0.06/12 =0.005 Number of payments =10 (12) = 120.
Monthly mortgage payment = 75,000(A/P, ½ %, 120) =75,000(0.0111) =$832.50
Problem 4-20

Assume that you have graduated and have gotten a good job (dream on!). You are conscientious and want to
begin a savings account. You are paid monthly and have authorized your bank to automatically withdraw
$300.00 from each paycheck. The bank made the first withdrawal on July 1, 2008, and you instruct them to
make the last withdrawal on April 1, 2035. The bank pays a nominal interest rate of 8% and compounds
quarterly. The money is deposited monthly. Interest is paid and accrued quarterly. What will be the balance of
the account on April 1, 2027?

Solution:

i =2%/quarter A = $300 ×3 =$900

F = $900 × (F/A, 2%, 100) =$900 × 312.23 = $281,007

Problem 4-26

You want to buy a house and can pay a $5,000 down payment and a mortgage payment of $500 each month.
Thirty-year mortgage loans are available for 6% per year. What is the most expensive house you can buy?

Solution:

Down payment = $5,000. Monthly mortgage payment = A = $500.

Loan data: n = 30. i = 6% per year.
A = P × (A/P, i, n).
500 = (P – 5,000) × (A/P, 12%/12, 30×12)
= (P – 5,000) × (0.0006).
Solving for P, we get, P = 5,000 + (500/0.0006) = $88,333.33.

Problem 4-53

For the cash flow diagram shown below, compute the value of P.

$5,000
$500
0

1 2 3 4

P=? i = 10%

Solution:

P = 500 (P/F, 10%, 1) + 5,000 (P/F, 10%, 4)

= 500 (0.9091) + 5,000 (0.6830)
= $3,869.55
Problem 4-57

A financial institution offers a daily compounding of interest to its depositors. It advertises the nominal interest
of 7%. Compute the equivalent annual uniform series of withdrawals someone could withdraw from the
account for 30 years if $1,000,000 is deposited now.

Solution:

P = $1,000,000. r = 7%.
ie = (1+r/m)m - 1 = (1 + 0.07/365)365 - 1 = 7.25%. nyr = 30.
A = P×(A/P, i, n) = 1,000,000 × (A/P, 7.25%, 30) = 1,000,000 × 0.08262 = $82,620.

Problem 4-65

A lease of production equipment at Kal Tech Engineering requires a payment of $50,000 at the beginning every
year for the next 6 years. If the interest rate is 8%, compute the present worth of this lease.
Solution:

There are a total of 6 payments each at the beginning of the year.

P = 50,000+50,000(P/A, 8%, 5) = 50,000 +50,000(4.623) =$28,115