Normal Profits and returns on investments

MULTIPLE CHOICE QUESTIONS (MCQ) – PREPARING

FOR THE FIRST MIDTERM

Opportunity Costs & the Production Possibility Frontier

Q1 Opportunity costs are defined as:

The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.

Q2 Assume that Kelly's various possible activities are mutually exclusive. The opportunity cost from choosing one activity equals the

value of the next most valuable alternative activity

Q3 Carl is considering attending a concert with a ticket price of £35. He estimates that the cost of driving to the concert and parking there will total an additional £20. In order to attend the concert, Carl will have to take time off from his part-time job. He estimates that he will lose 5 hours at work, at a wage of £6 per hour. Carl's opportunity cost of attending the concert equals,

£85

Q4 High-income people will sometimes pay higher prices at convenience stores for goods that are available at discount stores. They do this because

crowded and understaffed discount stores impose higher time costs

Q5 In America, the professional basketball players' union negotiates a contract that dramatically increases all players' salaries. How would this influence the opportunity cost for a player who was considering giving up basketball to pursue a career in broadcasting?

it would increase the opportunity cost of becoming a broadcaster

Q6 When a production possibilities frontier is bowed outward, as more of one good is produced, its opportunity cost,

increases

Q7 If an economy is producing a combination of goods inside its production possibilities frontier,

then,

some resources are being wasted or underused

Q8 When there is an improvement in technology, holding all else constant,

the production possibilities frontier will shift outward

Figure No. 1

Q9 Assume that UK agricultural land is used either to raise cattle for beef or to grow wheat. Figure No. 1 (right) represents the production possibility frontier for beef and wheat. Between points F and G, the opportunity cost of one bushel of wheat equals

0.125 pounds of beef ((2,25-2)/ (7-5))

Q10 Assume that UK agricultural land is used either to raise cattle for beef or to grow wheat. Figure No. 1

represents the production possibility frontier for beef and wheat. Production at point H is,

unattainable given currently available technology and resources

Normal Profits and returns on investments

Q11 In the context of investing, which of the following are correct definitions of capital?

1. Capital is money that is invested to make more money

2. Money that is available for investment, or any asset that can be readily turned in to money

3. Land owned by the state, but which citizens can use as collateral to back investment plans

4. The money, property, and other valuables which collectively represent the wealth of an individual or business.

5. Human resources considered in terms of their contributions to a business or an economy

All of them

Q12 To turn capital in to money, requires which of the following?

1. Its ownership is clearly established.

2. Its value can be measured.

3. Its title (ownership) can be transferred.

4. There is a market for it.

5. There is law that upholds the concept of private ownership

All of them

Q13 The following statements all describe aspects of Capitalism, which of the following statements is incorrect?

Under Capitalism there is no role for the state other than to protect and advance national interests.

Q14 In the context of a business, limited liability means which of the following

A person's financial liability is limited to a fixed sum, most commonly the value of a person's investment in a company or partnership with limited liability.

Q15 When investing in a business, owners and shareholders would expect to make at least a normal profit. In this context Normal Profit is which of the following?

The opportunity cost of being in business: the profit that could have been earned in the next best alternative business

Q16 Whencalculating the rate of normal profit (% NP) which formula is used?

% NP = the rate of return on a risk free loan + a risk premium.

Q17 In terms of a normal profit which of the following statements are TRUE?

1. The ‘risk free loan’ is a bank deposit or buying a government bond

2. The ‘risk premium’ compensates the investor for taking on the risk associated with the business.

3. The risk premium will vary depending on the nature of the business.

4. Government bonds of all countries are considered 'risk free'.

1, 2, and 3

Q18 If the rate of a riskless loan is 5% and the risk premium is 10%, and assuming the rate of annual inflation is 2.5%, an investment of £500,000 should return an annual normal profit of:

£62,500

Q19 An owner of a small firm wishes to retire and therefore decides to sell their business. Declared (and audited) net profits for the last 3 years have remained very stable at £65,000 pa. Industry analysts suggest that the rate of normal profit (or the rate of return on capital employed – ROCE), for this line of business, should be 12% (assuming bank rates are 5%). Based on these historical profits alone, how much is this business worth to another new investor/owner?

A) £541,666

Q20 In terms of 'activist shareholders' which of the following statements is incorrect

1. An activist shareholder uses an equity stake in a corporation to put public pressure on its management. 2. The goals of activist shareholders range from financial (e.g. increase of shareholder value) to non-financial (disinvestment from particular countries, adoption of environmentally friendly policies, etc.).

3. The attraction of shareholder activism lies in its comparative cheapness; a fairly small stake (less than 10% of outstanding shares) may be enough to launch a successful campaign.

4. Shareholder activism can take any of several forms: proxy battles, publicity campaigns, shareholder resolutions, litigation, and negotiations with management.

5. Due to the increasing popularity of the internet, smaller shareholders have also gained an outlet to voice their opinions.

all the above statements are correct.

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