Question

Darian and Ivan have been friends since college. They started a limousine rental business from scratch. They are now contemplating opening their business in Baltimore a new city for their business. They have crunched the numbers and discover it would mean adding $2 million more in expenses, and their profit would increase by $250,000 each year for the next 5 years (all other things equal). Darian and Ivan decide

a) to open in a second city because the marginal cost of the new location is low compared to other similar projects.

b) to take on the new location of Baltimore because the expected marginal benefit is greater than the estimated marginal cost.

c) to not open in a new city because the marginal costs prove to be too high.

Answer 1

From the question we get the information that expense of opening business in Baltimore would be $ 2 million and the profit will grow by $250,000 for next 5 years.

If we consider the interest rate to be zero , then also the total expense of opening business in Baltimore will be $2 million and the total extra revenue that will be generated in the next 5 years will be

5 * 250,000 = $1,250,000 = $1.25 million

We can see that the cost of starting the business will be more than the extra revenue generated by the new business, as $ 2 million > $1,250,000

So Darian and Ivan will decide to not open in a new city because the marginal costs prove to be very high. So option C is the correct answer.