Exam 1: Managers, Profits, and Markets

Surle Labs produces a single pharmaceutical drug, Zolax, for which the patent expires in four years. After the patent expires, Surle will earn no more economic profits after the fourth year passes because 1) dozens of firms will produce a generic version of Zolax that will drive the price of Zolax down to unit costs, and 2) it has invested nothing in research and development of new drugs and so will have no new sources of profit when the patent on Zolax expires in four years. You work as a research assistant for an investment-banking firm that specializes in acquisitions of pharmaceutical firms. After examining the financial statements of Surle Labs, you predict that Surle will earn $23 million in economic profit in EACH of the next four years, after which, it will earn zero economic profit forever. Your job is to advise a potential buyer of the drug firm on the market value of this firm. You believe 12 percent is the appropriate risk-adjusted discount rate for valuing Surle Labs. a. You estimate (i.e., compute) the value of Surle to be $___________________. b. If conditions in the market deteriorate making investment in drug firms more risky than you had originally anticipated, then you will need to use ____________(a lower, a higher, the same) risk-adjusted discount rate, which will _______________(decrease, increase, not affect) the value of Surle Labs.

Which of the following is a common mistake managers make?

A risk premium is

In a perfectly competitive market,

Which of the following is NOT one of features characterizing market structures?

Owners of a firm want the managers to make business decisions that will

Until recently you worked as an accountant, earning $30,000 annually. Then you inherited a piece of commercial real estate bringing in $12,000 in rent annually. You decided to leave your job and operate a video rental store in the office space you inherited. At the end of the first year, your books showed total revenues of $60,000 and total costs of $30,000 for video purchases, utilities, taxes, and supplies. What is the total cost of operating the video store?

Fill in the blanks in the following questions. Some blanks require TWO words. - a. ____________________ provides the foundation for understanding strategic decisions through the application of game theory. b. The everyday business decisions managers routinely make in running a business are frequently referred to as __________________________. c. Strategic decisions seek to alter the ________________ of rival firms in order to protect the long-run _____________ of the firm. d. When a firm earns zero economic profit, __________________________ equals total economic cost and ____________________ profit is positive. e. _______________ profit best measures the performance of a firm because it considers all the costs to a firm of using resources. f. The value of a firm is ________________ (larger, smaller) the higher is the risk premium used to compute the firm's value. g. In markets characterized by monopolistic competition, a large number of relatively small firms sell a ____________________________ product. h. The value of a firm is ________________ (larger, smaller) the lower is the risk premium used to compute the firm's value. i. The difference between accounting and economic profit is equal to the costs the firm incurs for using ______________________ resources. j. In corporations, the principals are the ____________________ and the agents are the _______________. k. Agency problems for firms arise because of moral _______________. l. Equity ownership is one of the most effective mechanisms for improving corporate __________________ . m. The value of the monitoring service provided by boards of directors is enhanced by appointing _____________________ and by linking directors' compensation to the _______________ of the firm. n. Increasing output in order to decrease ____________________ is a common mistake managers make. o. The pursuit of market _________________ is not usually going to maximize profit or the value of the firm. p. Maximizing profit margin _________(is, is not) generally consistent with maximizing profit and the value of the firm. q. Managers that make pricing and output decisions with the goal of maximizing total revenue _______ (will, will not) be maximizing profit in most circumstances.

At the beginning of 2014, market analysts expect Atlantis Company, holder of a valuable patent, to earn the following stream of economic profits over the next five years. At the end of five years, Atlantis will lose its patent protection, and analysts expect economic profit to be zero after five years. EXpected Economic Year Profit 2014 \ 225,000 2015 \ 325,000 2016 \ 425,000 2017 \ 200,000 2018 \ 100,000 If investors apply an annual risk-adjusted discount rate of 15%, the value of Atlantis Company in 2014 is $______________________, which is also the maximum price investors would be willing to pay for Atlantis Company.

A price-taking firm can exert no control over price because

During a year of operation, a firm collects $450,000 in revenue and spends $100,000 on labor expense, raw materials, rent, and utilities. The firm's owner has provided $750,000 of her own money instead of investing the money and earning a 10% annual rate of return. a. The explicit opportunity costs of using market-supplied resources are $______________. The implicit opportunity costs of using owner-supplied resources are $______________. Total economic cost is $______________. b. The firm earns economic profit of $______________. c. The firm's accounting profit is $______________. d. If the owner could earn 15% annually on the money she has invested in the firm, the economic profit of the firm would be ______________ (when revenue is $450,000).

The value of a firm is

Which of the following economic forces promote profitability in the long run?

Consider a firm that employs some resources that are owned by the firm. When accounting profit is zero, economic profit

When a firm earns less than a normal profit,

St. Charles Hospital, located in an upper-income neighborhood of a large city, recently received a restored mansion as a gift from an appreciative patient. The board of directors decided to remodel the mansion and use it as recuperative quarters for patients willing to pay a premium for luxurious accommodations. The cost to the hospital of using the mansion includes

A market

Economic profit is the best measure of a firm's performance because

Which of the following is NOT a characteristic of monopoly market structures?

Which of the following is a common mistake managers make?