1. The profitability of the leading cola syrup manufacturers PepsiCo and Coca-Colaand of the bottlers in the cola business is very different. PepsiCo and Coca-Colaenjoy an 81 percent operating profit as a percentage of sales; bottlers experienceonly a 15 percent operating profit as a percentage of sales. Perform a Porter's FiveForces analysis that explains why one type of business is potentially so profitable relative to the other.
2. Ethanol is again viewed as one part of a solution to the problem of shortages ofpetroleum products. Ethanol is made from a blend of gasoline and alcohol derivedfrom corn or sugar cane. What would you expect the impact ofthis program to beon the price of corn, soybeans, and wheat?
3. Royersford Knitting Mills, Ltd., sells a line of women's knit underwear. The firmnow sells about 20,000 pairs a year at an average price of $10 each. Fixed costsamount to $60,000, and total variable costs equal $120,000. The production department has estimated that a 10 percent increase in output would not affect fixedcosts but would reduce average variable cost by 40 cents.
The marketing department advocates a price reduction of 5 percent to increasesales, total revenues, and profits. The arc elasticity of demand with respect toprices is estimated at -2.
a. Evaluate the impact of the proposal to cut prices on (i) total revenue, (ii) totalcost, and (iii) total profits.
b. If average variable costs are assumed to remain constant over a 10 percent increase in output, evaluate the effects of the proposed price cut on total profits.
Which of the following products and services are likely to encounter adverse selection problems: golf shirts at traveling pro tournaments, certified gemstonesfrom Tiffany's, graduation gift travel packages, or mail-order auto parts? Why orwhy not?
Price and Output Determination:Monopoly and Dominant Firms
1 . Information Resources, Inc. (IRI), collects data on consumer packaged goods at32,000 scanner checkout counters and in panel surveys of 70,000 households. IRIrecords indicate that department store-brand pantyhose sell for a gross margin of43 percent and a contribution margin of29 percent, and the store inventory turnsover 14 times per year.
a. What expenses explain the difference between 43 percent and 29 percent?
b. What percentage change in unit sales is required to increase total contributions if price is cut by 10 percent?
c. Compare store-brand pantyhose with the products in Table 11.1. Whyshould Whitman's Sampler sell for a contribution margin of 54 percentwhen pantyhose sell for 29 percent?
2. The Lumins Lamp Company, a producer of old-style oil lamps, estimated thefollowing demand function for its product:
Q = 120,000 - 10,000P
where Q is the quantity demanded per year and P is the price per lamp. The?rm's ?xed costs are $12,000 and variable costs are $1.50 per lamp.
a. Write an equation for the total revenue (TR) function in terms of Q.
b. Specify the marginal revenue function.
c. Write an equation for the total cost (TC) function in terms of Q.
d. Specify the marginal cost function.
3. Unique Creations holds a monopoly position in the production and sale of magnometers. The cost function facing Unique is estimated to beTC = $100,000 + 20Q
a. What is the marginal cost for Unique?
b. If the price elasticity of demand for Unique is currently -1.5, what priceshould Unique charge?
c. What is the marginal revenue at the price computed in Part (b)?
d. If a competitor develops a substitute for the magnometer and the priceelasticity increases to -3.0, what price should Unique charge?
4. Wyandotte Chemical Company sells various chemicals to the automobile industry. Wyandotte currently sells 30,000 gallons ofpolyol per year at an average priceof $15 per gallon. Fixed costs of manufacturing polyol are $90,000 per year andtotal variable costs equal $180,000. The operations research department has estimated that a 15 percent increase in output would not affect fixed costs but wouldreduce average variable costs by 60 cents per gallon. The marketing departmenthas estimated the arc elasticity of demand for polyol to be -2.0.
a. How much would Wyandotte have to reduce the price ofpolyol to achieve a15 percent increase in the quantity sold?
b. Evaluate the impact of such a price cut on (i) total revenue, (ii) total costs,and (iii) total profits.
5. The Odessa Independent Phone Company (OIPC) is currently engaged in a ratecase that will set rates for its Midland-Odessa area customer base. OIPC has totalassets of $20 million. The Texas Public Utility Commission has determined thatan 11 percent return on assets is fair. OIPC has estimated its annual demandfunction as follows:
P = 3,514 - 0.08Q
Its total cost function (not including the cost of capital) is
TC = 2,300,000 + 130Q
a. OIPC has proposed a rate of $250 per year for each customer. If this rate isapproved, what return on assets will OIPC earn?
b. What rate can OIPC charge if the commission wants to limit the return onassets to 11 percent?
c. What problem of utility regulation does this exercise illustrate?
Price and Output Determination:Oligopoly
6. Assume that two companies (A and B) are duopolists who produce identical products. Demand for the products is given by the following linear demand function:
p = 200 - QA - QB
where QA and QB are the quantities sold by the respective firms and P is the selling price. Total cost functions for the two companies are
TCA = 1,500 + 55QA + Q2
A
TCB = 1,200 + 20QB + 2Q2
B
Assume that the firms act independently as in the Cournot model (i.e., each firmassumes that the other firm's output will not change).
a. Determine the long-run equilibrium output and selling price for each firm.
b. Determine Firm A, Firm B, and total industry profits at the equilibrium solution found in Part (a).
7. Alchem (L) is the price leader in the polyglue market. All 10 other manufacturers(follower [F] firms) sell polyglue at the same price as Alchem. Alchem allows theother firms to sell as much as they wish at the established price and supplies theremainder of the demand itself. Total demand for polyglue is given by the following function (QT = QL + QF):
P = 20,000 - 4QT
Alchem's marginal cost function for manufacturing and selling polyglue is
MCL = 5,000 + 5QL
The aggregate marginal cost function for the other manufacturers of polyglue is
∑MCF = 2,000 + 4QF
a. To maximize profits, how much polyglue should Alchem produce and whatprice should it charge?
b. What is the total market demand for polyglue at the price established by Alchem in Part (a)? How much of total demand do the follower firms supply?
Pricing Techniques and Analysis
8. The price elasticity of demand for a textbook sold in the United States is estimated to be -2.0, whereas the price elasticity ofdemand for books sold overseas is-3.0. The U.S. market requires hardcover books with a marginal cost of $40; theoverseas market is normally served with softcover texts on newsprint, having amarginal cost of only $15. Calculate the profit-maximizing price in each market.
Hint: Remember that MR = P (1 + (1/ED))
9. American Export-Import Shipping Company operates a general cargo carrier service between New York and several Western European ports. It hauls two majorcategories of freight: manufactured items and semimanufactured raw materials.
The demand functions for these two classes of goods are
P1 = 100 - 2Q1
P2 = 80 - Q2
where Qi = tons of freight moved. The total cost function for American is
TC = 20 + 4(Q1 + Q2)
a. Determine the firm's total profit function.
b. What are the profit-maximizing levels of price and output for the twofreight categories?
c. At these levels of output, calculate the marginal revenue in each market.
d. What are American's total profits if it is effectively able to charge differentprices in the two markets?
e. If American is required by law to charge the same per-ton rate to all users,calculate the new profit-maximizing level of price and output. What are theprofits in this situation?
10. Phillips Industries manufactures a certain product that can be sold directly to retail outlets or to the Superior Company for further processing and eventual sale asa completely different product. The demand function for each of these markets is
Retail Outlets: P1 = 60 - 2Q1
Superior Company: P2 = 40 - Q2
where P1 and P2 are the prices charged and Q1 and Q2 are the quantities sold inthe respective markets. Phillips' total cost function for the manufacture of thisproduct isTC = 10 + 8(Q1 + Q2)
a. Determine Phillips' total profit function.
b. What are the profit-maximizing price and output levels for the product inthe two markets?
c. At these levels of output, calculate the marginal revenue in each market.
d. What are Phillips' total profits if the firm is effectively able to charge different prices in the two markets?
e. Calculate the profit-maximizing level of price and output if Phillips is required to charge the same price per unit in each market. What are Phillips'profits under this condition?
PART VORGANIZATIONAL ARCHITECTUREAND REGULATION
Long-Term Investment Analysis
11 . A firm has the opportunity to invest in a project having an initial outlay of$20,000. Net cash inflows (before depreciation and taxes) are expected to be$5,000 per year for five years. The firm uses the straight-line depreciation methodwith a zero salvage value and has a (marginal) income tax rate of 40 percent. Thefirm's cost of capital is 12 percent.
a. Compute the internal rate of return and the net present value.
b. Should the firm accept or reject the project?
12. A machine that costs $12,000 is expected to operate for 10 years. The estimatedsalvage value at the end of 10 years is $0. The machine is expected to save thecompany $2,331 per year before taxes and depreciation. The company depreciatesits assets on a straight-line basis and has a marginal tax rate of 40 percent. Thefirm's cost of capital is 14 percent. Based on the internal rate of return criterion,should this machine be purchased?
13. Panhandle Industries, Inc. currently pays an annual common stock dividend of$2.20 per share. The company's dividend has grown steadily over the past 10years at 8 percent per year; this growth trend is expected to continue for the foreseeable future. The company's present dividend payout ratio, also expected tocontinue, is 40 percent. In addition, the stock presently sells at eight times currentearnings-that is, its "multiple" is 8.
Calculate the company's cost of equity capital using the dividend capitalizationmodel approach.
14. The Williams Company has a present capital structure (that it considers optimal)consisting of 30 percent long-term debt and 70 percent common equity. Thecompany plans to finance next year's capital budget with additional long-termdebt and retained earnings. New debt can be issued at a coupon interest rate of10 percent. The cost of retained earnings (internal equity) is estimated at 15 percent. The company's marginal tax rate is 40 percent.
Calculate the company's weighted cost of capital for the coming year.
Business and Economic Forecasting
15. Metropolitan Hospital has estimated its average monthly bed needs as
N = 1,000 + 9X
where X = time period ðmonthsÞ; January 2002 = 0
N = monthly bed needs
Assume that no new hospital additions are expected in the area in the foreseeable
future. The following monthly seasonal adjustment factors have been estimated,
using data from the past five years:
M O NT H AD J US TM E NT F AC T O R
January +5%
April -15%
July +4%
November -5%
December -25%
a. Forecast Metropolitan's bed demand for January, April, July, November, andDecember 2007.
b. If the following actual and forecast values for June bed demands have beenrecorded, what seasonal adjustment factor would you recommend be used inmaking future June forecasts?
YE AR F O RE CAS T AC T UAL
2007 1,045 1,096
2006 937 993
2005 829 897
2004 721 751
2003 613 628
2002 505 560
16. The economic analysis division of Mapco Enterprises has estimated the demandfunction for its line of weed trimmers asQD = 18,000 + 0.4N - 350PM + 90PS
where N = number of new homes completed in the primary market area
PM = price of the Mapco trimmer
PS = price of its competitor's Surefire trimmer
In 2010, 15,000 new homes are expected to be completed in the primary marketarea. Mapco plans to charge $50 for its trimmer. The Surefire trimmer is expectedto sell for $55.
a. What sales are forecast for 2010 under these conditions?
b. Ifits competitor cuts the price ofthe Surefire trimmer to $50, what effect willthis have on Mapco's sales?
c. What effect would a 30 percent reduction in the number of new homescompleted have on Mapco's sales (ignore the impact of the price cut of theSurefire trimmer)?