ISE 460 – Problem Set 1
Assigned Problems
• Chapter 1: 26, 57, 62, 66
• Chapter 2: 2, 17, 22, 41, 79
• Chapter 3: 5, 9, 22, 24, 28, 33, 36, 46, 52, 54, 57
Chapter 1 – Problem 26 (1-26)
(a) Considering only the direct costs
Data:
A: Direct 750, Extra 150, Income 1200
B: Direct 800, Extra 450, Income 1400
C: Direct 1000, Extra 250, Income 1500
D: Direct 1300, Extra 200, Income 1650
If only direct costs are considered, the contribution is
Contribution = Income − Direct.
A: 1200 − 750 = 450
B: 1400 − 800 = 600
C: 1500 − 1000 = 500
D: 1650 − 1300 = 350
Therefore, choose option B.
(b) Considering both the direct and extra-market costs
Now the contribution is
Contribution = Income − Direct − Extra.
A: 1200 − 750 − 150 = 300
B: 1400 − 800 − 450 = 150
C: 1500 − 1000 − 250 = 250
D: 1650 − 1300 − 200 = 150
Therefore, choose option A.
1
Chapter 1 – Problem 57 (1-57)
Given:
• Cost of goods sold (COGS) is 65% of sales ⇒ gross margin is 35% of sales.
• Incremental operating cost is $23 per hour.
For each period:
Net contribution = 0.35(Sales) − 23(Hours).
Time period Hours Sales 0.35×Sales Cost Net con-
(23 × h) tribution
0600–0700 1 40 14.00 23 −9.00
0700–0800 1 70 24.50 23 +1.50
0800–0900 1 120 42.00 23 +19.00
0900–1200 3 400 140.00 69 +71.00
1200–1500 3 450 157.50 69 +88.50
1500–1800 3 500 175.00 69 +106.00
1800–2000 2 600 210.00 46 +164.00
2000–2200 2 200 70.00 46 +24.00
2200–2300 1 50 17.50 23 −5.50
2300–2400 1 85 29.75 23 +6.75
2400–0100 1 40 14.00 23 −9.00
The best contiguous set of periods is 0700–2400 (open at 0700 and close at midnight).
Result (recommended hours)
• Open: 0700
• Close: 2400 (midnight / 0000)
2
Chapter 1 – Problem 62 (1-62)
The demand (price–quantity) relationship is
P (Q) = 475 − 0.25Q,
where P is the selling price per unit (dollars) and Q is the annual quantity sold.
The annual revenue is
R(Q) = P (Q) Q
= (475 − 0.25Q)Q
= 475Q − 0.25Q2 .
The annual cost is
C(Q) = 48Q + 22,500.
Hence the profit function is
π(Q) = R(Q) − C(Q)
= 475Q − 0.25Q2 − (48Q + 22,500)
= −0.25Q2 + 427Q − 22,500.
To maximize profit, set the derivative to zero:
π ′ (Q) = −0.5Q + 427 = 0 ⇒ Q∗ = 854.
Since π ′′ (Q) = −0.5 < 0, this is a maximum.
At Q∗ = 854,
P ∗ = 475 − 0.25(854) = 261.50,
R(Q∗ ) = 261.50 × 854 = 223,321,
C(Q∗ ) = 48(854) + 22,500 = 63,492,
so the maximum profit is
π(Q∗ ) = 223,321 − 63,492 = 159,829.
Therefore, the firm should produce and sell Q∗ = 854 units per year, earning a maximum
annual profit of $159,829.
3
Chapter 1 – Problem 66 (1-66)
(a) Economic criterion and estimated production rate
An appropriate economic criterion is to maximize the profit rate (profit per hour):
π(Q) = R(Q) − C(Q),
where R(Q) = P (Q) Q is the revenue per hour and C(Q) is the total cost per hour. Note
that the cost graph is in $1000/hr, so reported costs must be multiplied by 1000 to obtain
dollars per hour.
From the graphs, the approximate data are:
• Selling price P ($/unit): P (50) = 150, P (100) = 100, P (150) = 90, P (200) = 80,
P (250) = 70.
• Total cost C ($1000/hr): C(50) = 3, C(100) = 5, C(150) = 7, C(200) = 14, C(250) = 20.
Compute revenue, cost, and profit (all in $/hr):
Q = 50 : R = 150(50) = 7,500, C = 3(1,000) = 3,000, π = 4,500,
Q = 100 : R = 100(100) = 10,000, C = 5(1,000) = 5,000, π = 5,000,
Q = 150 : R = 90(150) = 13,500, C = 7(1,000) = 7,000, π = 6,500,
Q = 200 : R = 80(200) = 16,000, C = 14(1,000) = 14,000, π = 2,000,
Q = 250 : R = 70(250) = 17,500, C = 20(1,000) = 20,000, π = −2,500.
The maximum profit rate occurs at Q ≈ 150 units/hr, with π ≈ $6,500 per hour. Thus,
the recommended production rate is about 150 units/hr.
(b) Comment on “maximize output with minimum input”
In general, it is not possible to simultaneously maximize output and minimize input (cost),
because producing more output typically requires greater input. The goals represent a trade-
off.
4
Chapter 2 – Problem 2 (2-2)
The unit price is discounted by quantity:
• First 1000 parts: $15 each.
• Next 1500 parts (from 1001 to 2500): $13 each.
• All parts in excess of 2500: $11 each.
Thus the total cost function is
15Q, 0 ≤ Q ≤ 1000,
C(Q) = 15(1000) + 13(Q − 1000), 1000 < Q ≤ 2500,
15(1000) + 13(1500) + 11(Q − 2500), Q > 2500.
The average cost is AC(Q) = C(Q)/Q. With this step-pricing schedule, the marginal cost
for the next unit equals the current tier price.
(a) Q = 650
9,750
C(650) = 15(650) = 9,750, AC = = 15, M C = 15.
650
(b) Q = 1250
C(1250) = 15(1000) + 13(1250 − 1000) = 15,000 + 3,250 = 18,250,
18,250
AC = = 14.6, M C = 13.
1250
(c) Q = 2500
C(2500) = 15(1000) + 13(1500) = 15,000 + 19,500 = 34,500,
34,500
AC = = 13.8.
2500
Since the marginal cost represents the cost of purchasing one additional unit, the next
unit after Q = 2500 falls into the $11 price tier. Therefore,
M C = 11.
(d) Q = 3500
C(3500) = 15(1000) + 13(1500) + 11(3500 − 2500) = 34,500 + 11,000 = 45,500,
45,500
AC = = 13, M C = 11.
3500
5
Chapter 2 – Problem 17 (2-17)
From the breakeven graph (vertical axis in dollars ×104 ):
• Total revenue passes through (0, 0) and (1000, 20 × 104 ).
• Total cost passes through (0, 10 × 104 ) and (1000, 20 × 104 ).
(a) Total revenue
The revenue line has slope
20 × 104 − 0
mR = = 200 dollars/unit,
1000 − 0
so
R(x) = 200x.
(b) Total cost
The cost line has intercept 10 × 104 = $100,000 and slope
20 × 104 − 10 × 104
mC = = 100 dollars/unit,
1000 − 0
so
C(x) = 100,000 + 100x.
(c) Breakeven level
Breakeven occurs when R(x) = C(x):
200x = 100,000 + 100x ⇒ x = 1000.
(d) Profit or loss at x = 1500
R(1500) = 200(1500) = 300,000, C(1500) = 100,000 + 100(1500) = 250,000,
π(1500) = R(1500) − C(1500) = 50,000.
Thus, there is a profit of $50,000.
(e) Marginal and average costs at x = 1500
The marginal cost is the slope of C(x):
M C = C ′ (x) = 100 dollars/unit.
The average cost at x = 1500 is
C(1500) 250,000
AC = = = 166.67 dollars/unit (approximately).
1500 1500
6
Chapter 2 – Problem 22 (2-22)
Variable cost is $20 per unit and fixed cost is $10,875. The price–demand relation is
P (D) = −0.25D + 250,
where D is annual demand (units sold/produced).
(a) Total cost and total revenue
Total cost:
C(D) = 10,875 + 20D.
Total revenue:
R(D) = D · P (D)
= D(−0.25D + 250)
= −0.25D2 + 250D.
Profit:
π(D) = R(D) − C(D)
= −0.25D2 + 250D − (10,875 + 20D)
= −0.25D2 + 230D − 10,875.
(b) Breakeven quantity
Breakeven occurs when π(D) = 0:
−0.25D2 + 230D − 10,875 = 0
⇒ D2 − 920D + 43,500 = 0 (multiply by − 4).
p √
920 ± 9202 − 4(43,500) 920 ± 672,400 920 ± 820
D= = = .
2 2 2
Thus, the breakeven quantities are
D = 50 and D = 870.
(c) Profit when total revenue is maximized
Revenue is a concave quadratic R(D) = −0.25D2 + 250D, maximized at
∗ −250
DR = = 500.
2(−0.25)
At D = 500,
R(500) = −0.25(5002 ) + 250(500) = 62,500,
C(500) = 10,875 + 20(500) = 20,875,
so
π(500) = R(500) − C(500) = 62,500 − 20,875 = 41,625.
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(d) Maximum possible profit
Profit is π(D) = −0.25D2 + 230D − 10,875, maximized at
−230
Dπ∗ = = 460.
2(−0.25)
At D = 460,
π(460) = −0.25(4602 ) + 230(460) − 10,875 = 42,025.
Therefore, the maximum possible profit is $42,025 (within 0 ≤ D ≤ 1000).
(e) Graphing information (key points to plot)
Graph R(D) = −0.25D2 + 250D and C(D) = 10,875 + 20D for 0 ≤ D ≤ 1000 with dollars
on the y-axis (e.g., 0 to 70,000). Useful points:
D P (D) R(D) C(D) π(D)
0 250.0 0 10,875 -10,875
50 237.5 11,875 11,875 0
460 135.0 62,100 20,075 42,025
500 125.0 62,500 20,875 41,625
870 32.5 28,275 28,275 0
1000 0.0 0 30,875 -30,875
The breakeven points are at D = 50 and D = 870. Mark the revenue maximum at
D = 500 and the profit maximum at D = 460.
8
Chapter 2 – Problem 41 (2-41)
(a) Cost of a 500-mile automobile trip
Gas used:
500 miles
Gallons = = 20 gal.
25 miles/gal
Fuel cost:
20 × $4 = $80.
Wear and tear:
500 × $0.65 = $325.
Estimated total trip cost:
$80 + $325 = $405.
(b) Total number of hours in an average human life (75 years)
Assuming 365 days per year,
days
75 yr × 365 = 27,375 days.
yr
Convert to hours:
27,375 × 24 = 657,000 hours.
Estimated total: ≈ 6.57 × 105 hours.
(c) Days to travel around the equator by hot air balloon
Approximate earth circumference using C = πd:
C ≈ π(4000) miles ≈ 12,566 miles.
At 100 miles/day, days required:
12,566
≈ 125.66 ≈ 126 days.
100
(d) Area of the United States if Kansas is average-sized
Estimate Kansas area:
AKS ≈ 390 × 200 = 78,000 mi2 .
Assuming 50 states of roughly average size, estimated U.S. area:
AU S ≈ 50 × 78,000 = 3,900,000 mi2 = 3.9 × 106 mi2 .
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Chapter 2 – Problem 79 (2-79)
All dollar amounts below are in $ millions.
Cash flow components
• Design costs (years −3 to −1): −0.75 each year (already incurred; sunk, but shown for
completeness).
• Equipment purchase at t = 0: −3.65.
• Annual operating costs (years 1–7): O&M 0.05 + materials/overhead 1.75 ⇒ total 1.80
per year.
• Salvage value at end of year 7: 0.10 × 3.65 = 0.365 (inflow in year 7).
• Revenues (years 1–7): 2.00, 2.50, 3.00, 3.50, 4.00, 3.25, 2.50.
Cash flow table
Year t Revenue Operating Cost Salvage Net Cash Flow
−3 0 0 0 −0.75
−2 0 0 0 −0.75
−1 0 0 0 −0.75
0 0 0 0 −3.65
1 2.00 1.80 0 0.20
2 2.50 1.80 0 0.70
3 3.00 1.80 0 1.20
4 3.50 1.80 0 1.70
5 4.00 1.80 0 2.20
6 3.25 1.80 0 1.45
7 2.50 1.80 0.365 1.065
Cash flow diagram (timeline)
Year t −3 −2 −1 0 1 2 3 4 5 6 7
Net CF ($M ) −0.75 −0.75 −0.75 −3.65 0.20 0.70 1.20 1.70 2.20 1.45 1.065
10
+$4.00 M Rev
+$3.50 M Rev
+$3.25 M Rev
+$3.00 M Rev
+$2.50 M Rev +$2.50 M Rev
+$2.00 M Rev
+$0.365 M Salvage
Years
time
−3 −2 −1 0 1 2 3 4 5 6 7
−$0.05 M −$0.05
O&M M −$0.05
O&M M −$0.05
O&M M −$0.05
O&M M −$0.05
O&M M −$0.05
O&M M O&M
−$0.75 M−$0.75 M−$0.75 M
−$1.75 M −$1.75
M&OHM −$1.75
M&OHM −$1.75
M&OHM −$1.75
M&OHM −$1.75
M&OHM −$1.75
M&OHM M&OH
−$3.65 M (Equip)
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Chapter 3 – Problem 5 (3-5)
For a principal P , annual rate r, and time t (years):
• Simple interest: Is = P rt, As = P (1 + rt).
• Compound interest (annual compounding): Ac = P (1 + r)t , Ic = Ac − P .
Case Simple Interest Is Simple Total As Compound Interest Ic Compound Total Ac
(a) P = $1,000, t = 2, r = 5% $100.00 $1,100.00 $102.50 $1,102.50
(b) P = $1,500, t = 5, r = 6% $450.00 $1,950.00 $507.34 $2,007.34
(c) P = $10,000, t = 10, r = 10% $10,000.00 $20,000.00 $15,937.42 $25,937.42
(d) P = $25,000, t = 15, r = 15% $56,250.00 $81,250.00 $178,426.54 $203,426.54
(e) P = $47,750, t = 20, r = 20% $191,000.00 $238,750.00 $1,782,870.40 $1,830,620.40
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Chapter 3 – Problem 9 (3-9)
Let i be each person’s (effective) annual interest rate (or minimum attractive rate of return,
MARR). Compare $500 today to $1000 received in 3 years by converting the future amount
to present worth:
1000
P W1000 = .
(1 + i)3
• If P W1000 < 500, then $500 today is preferred.
• If P W1000 > 500, then $1000 in 3 years is preferred.
• If P W1000 = 500, the two options are equivalent.
Magdalen
Magdalen prefers $500 today, so her interest rate must satisfy
1000
< 500 ⇒ (1 + i)3 > 2 ⇒ i > 21/3 − 1 ≈ 0.2599 (≈ 25.99%).
(1 + i)3
Miriam
Miriam prefers $1000 in 3 years, so her interest rate must satisfy
1000
> 500 ⇒ (1 + i)3 < 2 ⇒ i < 21/3 − 1 ≈ 25.99%.
(1 + i)3
Mary June
Mary June is indifferent, so her interest rate is exactly the breakeven value:
1000
= 500 ⇒ (1 + i)3 = 2 ⇒ i = 21/3 − 1 ≈ 0.2599 (≈ 25.99%).
(1 + i)3
Therefore, the different choices can be explained by different personal discount rates
(MARR): Magdalen has a higher rate than 25.99%, Miriam has a lower rate than 25.99%,
and Mary June’s rate is approximately 25.99%.
13
Chapter 3 – Problem 22 (3-22)
Let i = 2% per year and n = 4 years. To have $12,000 in 4 years, the required amount to
keep in the savings account today is the present worth:
F 12,000
P = n
= = 11,086.15 (approximately).
(1 + i) (1.02)4
Alvin has $16,000 today, so the maximum he can spend now is
16,000 − 11,086.15 = 4,913.85.
Therefore, he can spend up to $4,913.85 on a motorcycle now and still have enough to grow
to $12,000 in 4 years at 2%.
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Chapter 3 – Problem 24 (3-24)
Given P = $2,442, i = 3.5% per year, and n = 10 years, the maturity value is
F = P (F/P, i, n) = P (1 + i)n .
(a) Use the formula
F = 2,442(1.035)10 = 2,442(1.4105988) ≈ $3,444.68.
(b) Use interest tables and interpolation
From tables for n = 10:
(F/P, 3%, 10) = (1.03)10 ≈ 1.343916, (F/P, 4%, 10) = (1.04)10 ≈ 1.480244.
Interpolate linearly to 3.5%:
3.5 − 3
(F/P, 3.5%, 10) ≈ 1.343916 + (1.480244 − 1.343916) ≈ 1.412080.
4−3
Thus
F ≈ 2,442(1.412080) ≈ $3,448.30,
which is slightly different due to interpolation approximation.
(c) Use a calculator or spreadsheet (5-button solution)
F = 2,442 × (1.035)10 ≈ $3,444.68.
Using the Excel FV function:
F = FV(0.035, 10, 0, −2442) ≈ $3,444.68.
15
Chapter 3 – Problem 28 (3-28)
Deposit P = $4,000 for 3 years.
The local bank pays 5% per year, so the future value is
Flocal = 4,000(1.05)3 = 4,000(1.157625) = $4,630.50,
and the interest earned is
Ilocal = Flocal − P = 4,630.50 − 4,000 = $630.50.
The out-of-town bank pays 1.25% per quarter. Over 3 years there are
n = 3 × 4 = 12 quarters,
so the future value is
Fout = 4,000(1.0125)12 ≈ 4,000(1.1607545) = $4,643.02,
and the interest earned from the out-of-town bank is
Iout = Fout − P = 4,643.02 − 4,000 = $643.02.
Therefore, the interest obtained from the out-of-town bank over 3 years is $643.02 (ap-
proximately).
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Chapter 3 – Problem 33 (3-33)
The $160,000 paid two years ago is a sunk cost and should not affect the decision. The
relevant choice is whether to sell the land now for $200,000 or keep it and sell in 4 years for
$240,000, given the firm’s interest rate i = 5%.
Compute the present worth (at t = 0) of selling in 4 years:
240,000 240,000
P Wkeep = 4
= ≈ 197,448.17.
(1.05) 1.21550625
Selling now has present worth
P Wsell = 200,000.
Since P Wsell > P Wkeep , the firm should sell the land now.
Equivalently, the future worth of selling now and investing at 5% for 4 years is
F Wsell = 200,000(1.05)4 ≈ 243,101.25,
which exceeds $240,000. Therefore, selling now is economically preferable.
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Chapter 3 – Problem 36 (3-36)
An initial investment of P = $5,000 earns 9% annually for the first 6 years, then 3% annually
for the next 4 years. The future amount after 10 years is
F = 5,000(1.09)6 (1.03)4 .
Compute:
(1.09)6 ≈ 1.677100, (1.03)4 ≈ 1.125509.
Thus,
F ≈ 5,000(1.677100)(1.125509) ≈ 5,000(1.887605) ≈ $9,438.03.
Therefore, the account balance after 10 years is approximately $9,438.03.
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Chapter 3 – Problem 46 (3-46)
The 6-month (semiannual) interest rate is
13,000 − 12,000 1,000 1
i0.5 = = = = 0.083333 (≈ 8.3333%).
12,000 12,000 12
Nominal annual interest rate
With semiannual compounding, the nominal annual rate is
1 1
j = 2i0.5 = 2 = = 0.166667 (≈ 16.6667%).
12 6
Effective annual interest rate
2 2
2 1 13 169 25
ieff = (1+i0.5 ) −1 = 1 + −1 = −1 = −1 = = 0.173611 (≈ 17.3611%).
12 12 144 144
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Chapter 3 – Problem 52 (3-52)
The store charges 1.5% interest per month. Interpreting this as a nominal monthly rate
applied with continuous compounding, the continuous compounding rate per month is 0.015.
Nominal annual interest rate
The nominal annual rate (based on a monthly periodic rate of 1.5%) is
j = 12(0.015) = 0.18 ⇒ 18% per year (nominal).
Effective annual interest rate
With continuous compounding at a nominal annual rate j = 0.18,
ieff = e0.18 − 1 ≈ 0.197217 ⇒ 19.7217% per year (effective).
20
Chapter 3 – Problem 54 (3-54)
To choose the highest return, compare effective annual interest rates.
Option 1: 2.25% compounded every two months
Compounding every two months means m = 6 periods/year:
6
0.0225
ieff,1 = 1+ − 1 ≈ 0.022712 (2.2712%).
6
Option 2: 2.30% compounded quarterly
Quarterly compounding means m = 4 periods/year:
4
0.0230
ieff,2 = 1+ − 1 ≈ 0.023199 (2.3199%).
4
Option 3: 2.20% compounded continuously
ieff,3 = e0.0220 − 1 ≈ 0.022244 (2.2244%).
Since ieff,2 is the largest, he should select the 2.30% rate compounded quarterly.
21
Chapter 3 – Problem 57 (3-57)
Let t = 0 be the purchase date. The unit price is $350. Under the original contract, a
lump-sum payment is due at t = 2 with interest at a quarterly rate of 1.5%. Thus,
F2 = 350(1.015)8 ,
since there are 8 quarters in 2 years. Compute
(1.015)8 ≈ 1.12649 ⇒ F2 ≈ 350(1.12649) = $394.27.
To compare the alternatives at the 18th month (t = 1.5), convert the contract amount
from t = 2 back 6 months (2 quarters):
F2 394.27 394.27
P1.5 = 2
= 2
≈ = $382.73.
(1.015) (1.015) 1.030225
Apex’s alternative is $350 with interest at 10% per semiannual period for 6 months, so
the amount to be paid at t = 1.5 is
F1.5 = 350(1.10) = $385.00.
Comparing at t = 1.5: since $382.73 < $385.00, Marty should choose the original contract
(option with the smaller equivalent payment at the 18th month).
22