Suppose that five car companies are considering borrowing $5,000 each to buy a n

Question

Suppose that five car companies are considering borrowing $5,000 each to buy a new car assembly machine. If a company decides to buy the new machine, then they must borrow $5,000.

The annual real returns on these machines, also known as the value of marginal product of capital, are shown in the table below. The value of marginal product of capital is revenue net of operating costs, taxes, and opportunity costs, but it does not account for the interest payment. Assume that the car assembly machines can always be resold at their original price.

Company Value of Marginal Product of Capital (per Year)
A $550
B $450
C $350
D $250
E $150


4.1. If the annual real interest rate on the loans is 6%, how many car companies will buy a new car assembly machine? Interest payments are made once a year.




A. Four companies

B. Zero companies

C. Five companies

D. Two companies

E. One company

F. Three companies

Explanation / Answer

Since rate on the loans is 6% that is 6% of $5000=$300=interest payments Now annual returns on the machines(Mar. product of capital)= revenue - operating costs- taxes - opportunity costs since the machines can be sold any time at their original value.. this means the machines for which Mar. product of capital>interest payments($300), only those will be bought by the companies... Now from the table it is clear that Mar. product of capital>interest payments for the companies A($550), B($450) and C($350). Hence three companies will buy a new car machine. hence ans--F. Three companies

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