Please Help..Economics Question.?

Question

It looks long but it's really not.

Suppose a manufacturer wants to add microwave ovens to his product line. To do this he must invest $500,000 in new equipment.
Besdies the original investment, the company estimates it would spend $200,000 per year on production costs like labor and materials. It also estimates that it could sell about $225,000-worth of ovens each year. Would it pay the firm to manufacture the microwave ovens if it could earn 10 percent interest by purchasing U.S. Treasury bonds with the $500,000? Explain your answer.







We are learning about opportunity cost so that probably has something to do with the answer but I just got confused by reading it. Any help is greatly appreciated.

Answer 1

If the direct costs are $200,000 per year and the sales are only $225,000 per year, your gross profit would be $25,000 per year before sales and administrative costs. How are you going to get back your sunk capital of $500,000? Go for the Treasury bonds. They also are free from state income taxes.

Answer 2

I want to verify I understand your question correctly prior to answering.
A Mfr has determined the initial investment necessary to produce and sell microwave ovens is $500,000 (New equipment cost.) The annual, ongoing cost to produce is estimated to be $200,000. The estimated annual sales revenue (not profit) is $225,000. Would the firm make more money if it produced and sold microwave ovens using this scenario, or if it bought $500,000 of Treasury Bonds and earned 10% annually on them? Did I get the scenario correct?

Answer 3

I'd say no - the opportunity cost in this case is $50,000 per year - the 10% interest that could be earned on the $500,000.
If you add that to the $200,000 in additional cost, the firm would have total annual costs of $250,000 to generate $225,000 in additional sales, and would be losing money. It would never recover the $500,000 originally invested.