H&A to problems on

Decision rule

João Confraria
jcfs@ucp.pt

Managerial Economics jc 1
From Baye and Prince chapter 1 - 7

• An engineer is considering applying to a 2-year MBA program.

a. Using the concept of net present value and opportunity cost, explain when it is rational for an individual
to pursue an MBA degree?
b. What would you expect to happen to the number of applicants if the starting salaries of managers with
MBA degrees remained constant but salaries of managers without such degrees decreased by 30%?
Why?

Managerial Economics jc 2
• Marginal cost of the decision: cost of the MBA
• Marginal benefit: benefit of the MBA

• MBA’s benefits and costs are spread over several years.

• The decision variable is the net present value (NPV) of an MBA.
• NPV = present value of benefits – present value of costs

• Annual costs
• Costs = tuition fees + travel + housing + books + implicit cost
• Tuition fees + travel + housing + books = F
• Let us assume that the implicit cost is the salary of an engineer without an MBA = S
• Annual benefits
• Benefits = salary of a manager with an MBA (M) – salary of a manager without an MBA (S)

Managerial Economics jc 3
• To calculate the present value of the net benefits:

-F-S -F-S M-S M-S

0 time

Decision Manager with

MBA degree

a. 𝑁𝑃𝑉 ⋯>0

• Note that S is always a cost. If S decreases NPV increases (and the MBA becomes more attractive.)

Managerial Economics jc 4
From Baye and Prince chapter 1 - 10

• An owner can lease a building for $120 000 per year for 3 years. The explicit cost of maintaining the building
is $40 000, and the implicit cost is $55 000. All revenues are received, and costs borne, at the end of the
year. The interest rate is 5%. Determine the present value of
a. Accounting profits
b. Economic profits
Note: the present value is calculated at the beginning of the first year.

Managerial Economics jc 5
From Baye and Prince chapter 1 - 10

a. The annual accounting profits are 120 000 – 40 000 = 80 000. The present value of accounting profits is
• PV 217 859,8
, , ,

b. The annual economic profits are 120 000 – 40 000 – 55 000 = 25 000.
PV 68 081,2
, , ,

Managerial Economics jc 6