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Running Head: CAPITAL BUDGETING
Capital Budgeting
Student Name:
Professor’s Name:
Institution:
Course:
Date:
CAPITAL BUDGETING
2
DQ1W6 – Price Elasticity of Demand
Since elasticity measures the responsiveness of the quantity demaned due to change in
the prices. So when the percentage change in the quantity demand is less than the percentage
change in the price, then the demand is said to be inelastic, while when the percentage change in
the quantity demand is more than the percentage change in the price, then the demand is said to
be elastic.
Hence when the demand for services of water, garbage collection, and electricity are
inelastic, the effect of price on the quantity demand of these services will be less, so when the
price is increased of these services, the quantity demand is decreased by less percentage. Hence
the with the increase in the price of these services, the total revenue increases.
Therefore with the increase in the price of these services, the total revenue can be
increased of the city.
DQ1W8 – Monopoly Markets
Monopoly underproduction means that a monopoly firm produces below the ideal (i.e.
efficient) output.
CAPITAL BUDGETING
3
Monopoly profit maximizing condition is MR=MC and monopoly demand curve (i.e. AR
curve) is downward sloping and we know when AR falls MR falls more than AR and hence lies
below it.
Perfect competition condition is P=MC at the point the economy produces efficient
output as nothing is left unsold. Each consumer gets what he/she wants at the price they are
willing to pay. So there is no deadweight loss in case of perfect competition because economy is
producing ideal output.
In monopoly the prices are high and output is low whereas in perfect competition prices
are low and output is high as compared to monopoly.
We can explain it with the help of diagram under different cases where MC is constant, a
straight line and non- linear.
CAPITAL BUDGETING
Hh
Consumer surplus
Producer surplus
4
perfect competition
a+b+c+d+e
0
Deadweight loss
monopoly
a+ b
c+d
change
-c-d-e
c+d
-e
CAPITAL BUDGETING
5
We see when economy moves from perfect competition to monopoly the consumer is worse off
as there is loss of surplus of (-c-d-e) whereas producer is better off there is addition to producer
surplus of (c+d) when we add both of them we get (-e) which indicate dead weight loss which
means this much amount of output is lost which was initially in use in case of perfect
competition.
DWL= Area of triangle shaded=(1/2)(Pm-Pc) (Qc-Qm)
Case where MC is straight line
CAPITAL BUDGETING
6
We see when economy moves from perfect competition to monopoly the consumer is
worse off as there is loss of surplus of (-c-d-e) whereas producer may be better off or worse off
depending on elasticity of price. There is addition to producer surplus of (c+d-h) when we add
both of them we get
( -e-h) which indicate dead weight loss which means this much amount of
output is lost which was initially in use in case of perfect competition
DWL= Area of triangle shaded=(1/2)(Pm-MCm) (Qc-Qm)
Case where MC is non-linear
CAPITAL BUDGETING
7
CAPITAL BUDGETING
8
Question 3 solution
Capital budgeting is simply a planning process that is actually used to define whether the
long term investment of a given organization i.e. new plant, new machinery, new products,
replacement of machines among others are basically worth of cash funding via the organization
firm structure (equity, debt or retained earnings) (Sheffrin & Steven, 2003)
The initial costs of a project are the costs basically incurred precisely during the
construction and design process (Stuart & Keith, 2006). A project cash flow helps one to be able
to determine how one is going to obtain money for the project.
Interest rate is precisely the charged amount and it is expressed as the principal’s
percentage for the person borrowing from the lender.
Net present value is simply the difference between the present cash outflow and the value
of the present cash inflow over a given period of time.
Cost of capital is precisely the opportunity cost for making a particular investment.
Internal Rate of Return is used in capital budgeting purposely to approximate the
profitability of investments.
This is the formula used to determine NPV (Net present value).
To be able to calculate IRR using the formula above, NPV should be set to zero and then
solve for r (discount rate) and this will be IRR.
Managers consider very many factors before they are able to invest. Fundamentally, they
would look at the capital budgeting among other things before deciding on any given investment.
CAPITAL BUDGETING
9
CAPITAL BUDGETING
10
CAPITAL BUDGETING
References
Stuart Anderson, Keith Molenaar and Cliff Schexnayder (2006), Guidance for Cost Estimation
and Management for Highway Projects During Planning, Programming, and
Preconstruction, NCHRP Report 574, TRB
11
CAPITAL BUDGETING
Sheffrin, Steven M. (2003). Economics: Principles in Action. Upper Saddle River, New Jersey
07458: Pearson Prentice Hall. p. 375.
12

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