Question

Darian and Ivan have been friends since college. They started a limousine rental business from scratch in Philadelphia. They are now contemplating opening an additional location for their business in Baltimore. 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

Answer 1

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

Step-by-step explanation:

This decision depends on if the new location will be worth the investment of $2,000,000 put into it. To check whether it will be worth it, the total Revenue expected over the amount of time that the location would be making revenue should be added up. If the sum is greater than $2 million then it is a viable Investment. If it is not, it should not be picked.

The prospective location is estimated to be able to add $250,000 per year in revenue over 5 years.

In 5 years that means

= 250,000 * 5

= $1,250,000 would be made in revenue.

This Revenue of $1,250,000 is far short of the $2 million that will be added in Expenses and so the Investment is not viable.

Darian and Ivan should not open in the new city because the Marginal Cost of Investment is too high to be covered by the Marginal Revenue.