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Week 1
Firm Objectives. Why do some business
firms pursue a triple-bottom-line outcome while others focus only on profit
maximization? Please, use a real company example to illustrate your points
Decision Making Under Uncertainty. To save
on gasoline expenses, Edith and Mathew agreed to carpool together for traveling
to and from work.
Edith preferred to travel on I-20 highway as it was usually the fastest, taking 25 minutes in the absence of traffic delays. Mathew pointed out that traffic jams on the highway can lead to long delays making the trip 45 minutes. He preferred to travel along Shea Boulevard, which was longer (35 minutes), but rarely had traffic jams. Edith agreed that in case of traffic jams, Shea Boulevard was a reasonable alternative. Neither of them knows the state of the highway ahead of time.
Edith preferred to travel on I-20 highway as it was usually the fastest, taking 25 minutes in the absence of traffic delays. Mathew pointed out that traffic jams on the highway can lead to long delays making the trip 45 minutes. He preferred to travel along Shea Boulevard, which was longer (35 minutes), but rarely had traffic jams. Edith agreed that in case of traffic jams, Shea Boulevard was a reasonable alternative. Neither of them knows the state of the highway ahead of time.
After
driving to work on the I-20 highway for 1 month (20 workdays), they found the
highway to be jammed 3 times. Assuming that this month is a good representation
of all months ahead, should Edith and Mathew continue to use the highway for
traveling to work?
How would
you conclusion change for the winter months, if bad weather makes it likely for
traffic jams on the highway to increase to 6 days per month?
How would
your conclusion change if Mathew purchased a new smart-phone app that could
show the status of the highway traffic prior to their drive each morning, thus
reducing the probability of them getting into a jam down to only 1day per month
(where on this day, the app showed no traffic jam, but a jam developed in the
meantime as they were driving along the highway).
Economics of Risk and Uncertainty Applied Problems. Please,
complete the following 3 applied problems in a Word or Excel document. Show all
your calculations and explain your results. Submit your assignment in the drop
box by using the Assignment Submission button.
1. A
generous university benefactor has agreed to donate a large amount of money for
student scholarships. The money can be provided in one lump-sum of $10mln, or in
parts, where $5.5mln can be provided in year 1, and another $5.5mln can be
provided in year 2. Assuming the opportunity interest rate is 6%, what is the
present value of the second alternative? Which of the two alternatives should
be chosen and why?
How would
your decision change if the opportunity interest rate was 12%? Please, show all
your calculations.
2.
Volkswagen is considering opening an Assembly Plant in Chattanooga, Tennessee,
for the production of its 2012 Passat, tailored for the US market. The CEO of
the company is considering two potential options for the size of the plant: one
is a large size with a projected annual production of 150,000 cars, and the
other one is a smaller size plant, which is cheaper to build, but can only
produce up to 80,000 cars per year. Depending on the expected level of demand
for these cars in the US, Volkswagen has to decide which option is more
profitable. The discount rate is 6% and for simplicity purposes, the CEO is
only evaluating a two-year horizon. The initial factory setup cost, the
expected demand scenarios, profit, and probabilities are shows in the below
table. Calculate the Net Present Value in each of the two options. Which option
should the CEO choose and why? Please, show all your calculations.
3. An angel
investor is considering investing in one of two start-up businesses and is
evaluating the expected returns along with the risk of each option in order to
choose the better alternative.
Business
1 is an innovative protein energy drink, which has ENPV of $100,000 with a
standard deviation of $40,000.
Business
2 is a unique chicken wings dipping sauce with an ENPV of $60,000 and a
standard deviation of $25,000.
a) Apply
the coefficient-of-variation decision criterion to these alternatives to find
out which is preferred by the angel investor, assuming that he/she is
risk-averse.
b) Apply
the maximin criterion, assuming that the worst outcome in Business 1 is to lose
$5,000, whereas the worst outcome in Business 2 is to make only $5,000 in
profit.
c) If you
were the angel investor, what is your certainty equivalent for these two
projects? Are you risk-averse, risk-neutral, or risk-lover?
Week 2
Marginal Rate of Substitution. What is the marginal rate
of substitution (MRS) and why does it diminish as the consumer substitutes one
product for another? Use examples to illustrate
Demand Elasticity. Please, read the article
Hainer, R. (2010), provided in the required readings section for this week. The
tobacco industry is a prime example to consider when talking about price
elasticity of demand. While nicotine use can be addictive for many users, it is
not addictive for the so-called "social smokers".
What can
we say about the price elasticity of demand for nicotine products (such as
cigarettes, pipes, tobacco) in the group of nicotine addicted users, versus the
group of "social smokers"? Can we say whose demand is likely to be
more elastic? Why?
Consumer Demand Analysis and Estimation Applied Problems. Please,
complete the following 3 applied problems in a Word or Excel document. Show all
your calculations and explain your results. Submit your assignment in the drop
box by using the Assignment Submission button.
1.
Roshima is researching universities where she could study for her MBA degree.
She is considering 3 major attributes that she considers important in her
choice: ranking, price, and location. The value she places on each attribute,
however, differs according to whether she remains full-time employed during her
studies or quits her job and focuses on her degree. If she continues to work
full time and takes all her courses online, then ranking is the most important
attribute, twice as important as price and three times as important as
location. If she quits her job and attends school full time, then location becomes
three times as important as ranking and twice as important as price. She is
considering two universities, respectively, the MBA program at Arizona State
University (ASU) and the MBA program at University of Phoenix (UOP), both of
which are priced at approximately $25,000. She has rated each attribute on a
scale of 1 to 100 for each of the two schools.
a. Which
of the two options should Roshima pursue of she wants to keep her full-time
job? (Calculate the total expected utility from each school option and compare.
Graph is not required)
b. Which
of the two options should she pick if she plans to quit her job and dedicate to
her studies?
c. Which
option should she pursue if the probability of being laid off and unable to
find a new job is estimated as 0.6? Show your calculations and explain your
reasoning.
2. The
demand function for Einstein Bagels has been estimated as follows:
– 40.73Px
+ 84.17Py + 0.55Ax
where Qx
represents thousands of bagels; Px is the price per bagel; Py is the average
price per bagel of other brands of bagels; and Ax represents thousands of
dollars spent advertising Einstein Bagels. The current values of the
independent variables are , , and
a.
Calculate the price elasticity of demand for Einstein’s Bagels and explain what
it means.
b. Derive
an expression for the (inverse) demand curve for Einsteins’s Bagels.
c. If the
cost of producing Einstein’s Bagels is constant at $0.10 per bagel, should they
reduce price and thereafter, sell more bagels (assume profit maximization is
the company’s goal)?
d. Should
Einstein Bagels spend more on advertising?
3. The
consulting firm that you work for has been hired by the US Government to
provide an independent analysis of the demand-side effects of a contemplated
increase in the tax on gasoline. They provide you with a data set relating to
the period 1962-1987, which they say contains valuable historic lessons
relating to the impact of volatile pump prices due to the supply restrictions
imposed by the Organization of Petroleum Exporting Countries (OPEC), and the
Corporate Average Fuel Economy (CAFE) regulations that required car
manufacturers to increase the fuel efficiency of the cars they sold, while at
the same time Real Disposable Income (RDI) per capita was rising, the number of
passenger cars (NPC) almost doubled, and inflation was pushing up the Consumer
Price Index (CPI).
Where: Qx
is the gasoline consumption by passenger cars (in millions of gallons);
Px is the
retail (pump) price of gasoline, in cents per gallon;
NPC is
the number of registered passenger cars (in thousands);
MPG is
the national average of miles travelled per gallon of gasoline;
RDI is
Real Disposable Income per capita (in 1982 dollars); and
CPI is
the Consumer Price Index (base year 1967).
This data
illustrates some very interesting issues that were happening over that
tumultuous period of our history. You will note that the pump price of gasoline
more than doubled five-fold from the mid-1960s to the mid-1970s, and then
doubled again in the early 1980s, due to the OPEC crises. The number of
passenger cars climbed relentlessly with the love affair with ‘muscle cars’
despite the increasing pump price of gasoline, and indeed outpacing the
increases in real disposable income per capita. The average MPG climbed only
slowly as manufacturers increased the fuel efficiency of new cars and consumers
slowly traded up to the more efficient cars new cars and retired their older
vehicles. The changes in CPI show that the rate of inflation was generally much
greater than the rate of increase of pump prices as the increased production
and transportation costs due to rising fuel prices pervaded the entire economy,
pushing up the prices of food and other household items that drive the CPI.
a.
Reconcile the fact that while the quantity demanded of gasoline and pump prices
both rise over this period generally, they are inversely related along a demand
curve.
b.
Conduct a multiple regression analysis to explain the quantity demanded of
gasoline in terms of the other data provided. (Transpose this data into an
Excel spread-sheet and use the Excel regression tool, if loaded, or
alternatively download an ‘add-in’ regression program such as ‘Statpro’ to find
the regression statistics).
Week 3
Relevant Costs. Two partners own together a small landscaping
business in North Carolina, called Summer Lawn Care. They have been
specializing in summer grass seeding, installation, and maintenance. Recently,
the partners acquired special technology and know-how for winter grass installations
and maintenance. They also added a tree cutting service as recent storms in the
area had caused demand for this service to soar. One of the partners insists
that the name of the business should change to Lawn and Tree Care, so that it
better reflects the range of services and, thus, generates more customer
interest, and thus contracts. The second partner wants to keep the old name and
argues, “We have already paid for business cards, vehicle paint, signage, and
ads in Yellow Pages”. Evaluate the arguments of the two partners. Explain and
illustrate their points by identifying the relevant and irrelevant costs for
this decision.
Contribution Analysis. Explain what is meant by
“contribution analysis”. Carefully define the term and provide examples to illustrate
it.
Production Cost Analysis and Estimation Applied Problems. Please,
complete the following 3 applied problems in a Word or Excel document. Show all
your calculations and explain your results. Submit your assignment in the drop
box by using the Assignment Submission button.
1.
Jennifer Trucking Company operates a large rig transportation business in Texas
that transports locally grown vegetables to San Diego, California. The company
owns 5 large rigs and hires local drivers paid fixed salaries monthly,
regardless of the number of trips or tons of cargo that each driver transports
each month. The below table presents details about the number of drivers and
the total cargo transported by the company at different staff levels.
a. Which
inputs are fixed and which are variable in the production function of Jennifer
Trucking Company? Over what ranges do there appear to be increasing, constant
and/or diminishing returns to the number of drivers employed?
b. What
number of drivers appears to be most efficient in terms of output per driver?
c. What
number of drivers appears to minimize the marginal cost of transportation
assuming that all drivers are paid the same salary?
2. The
Palms Dry Cleaning Shop in Fort Lauderdale, Florida, faces a highly seasonal demand
for its services, as the snow-birds retirees flock to Florida in mid-fall to
enjoy the mild winter weather and then return to their main homes in
mid-spring. Given this seasonality, Palms tries to keep the overhead costs as
low as possible and therefore, often uses seasonal contracted labor to man its
operations. The following table shows the labor costs in each month of
operation over the past 12 months as well as the total number of garments that
were dry-cleaned in each month. Palms pays fixed wages per hour to each
employee, and we can assume that the costs of other variable inputs (such as
chemicals, electricity, etc) have remained constant.
a. Derive
average variable cost (AVC) data from the data in this table.
b. Use
gradient analysis to provide an estimate of eleven data points that seem to
represent the MC curve over this range of outputs. Plot these data points and
sketch in estimated MC and AVC curves that seem to best fit these data points.
c.
Suppose that demand is estimated to move from its present (May) level of 3,500
units to 4,000 units next month (June). What is the incremental cost of meeting
this demand?
d.
Assuming that Palm’s price to dry clean a garment has been constant at $15 over
the past year, and will remain at that level, what contribution to overheads
and profit can it expect in June?
3. Over
the past 12 months the Four Winds Novelty Company firm has recorded its
internet sales (equals monthly output levels) and its monthly total variable
costs (TVC) for a particular novelty item as shown in the following table.
Sales have grown over this period with relatively few shocks due to
uncontrollable weather, political and sporting events. This online retailer
carries no inventories; when it receives a pre-paid on-line order from a
customer, it simply buys the product from a supplier and ships it out to the
customer.
a. Using
regression analysis, find an equation that best fits the data to represent the
TVC function.
b. At
what sales/output level will marginal costs (MC) reach a minimum?
c.
Estimate the value of TVC for sales/output level 250,000 units, and calculate
the 95% confidence interval for your estimate
Week 4
Strategic Behavior Oligopolies. An interesting example of
strategic behavior comes from a 1997 article about Microsoft’s investment in
Apple (New Straits Times, 1997). The article is included in the Required
Readings list. Facing tough anti-trust scrutiny from government agencies,
Microsoft provided financial support to Apple in order to ensure Apple’s
survival and, therefore, to ensure that competitiveness in the industry
remains. Moreover, the partnership with Apple provided an additional market for
Microsoft’s products – the MS Office and the IE products were to be bundled
with the MAC OS as one of the conditions for this financing. Discuss this case
in the context of market structure and strategic behavior. What market
structure do these firms operate in? Why did Microsoft need to preserve
competitiveness in the industry? What was Microsoft afraid of in the event that
Apple did not survive?
Local Market Power. Bulls Eye department
store specializes in the sales of discounted clothing, shoes, household items,
etc. similar to the offerings at a regular Walmart or Target. Bulls Eye is the
only department store in Show Low and the nearest other discount retailer is
Target, located 49 miles away in Eagar. Bulls Eye, therefore, has some market
power in its local area. Despite having some market power, Bulls Eye is
currently suffering losses. An analyst at Bulls Eye is recommending to the
manager to raise prices, so that profitability can be improved. The manager is
unsure of this strategy as recent data points to increasing numbers of
individuals shopping more and more. What are the pros and cons of raising the
prices at Bulls Eye and would that strategy be profitable?
Market Structures and Pricing Decisions Applied Problems. Please,
complete the following 2 applied problems in a Word or Excel document. Show all
your calculations and explain your results. Submit your assignment in the drop
box by using the Assignment Submission button.
A small
business which produces plastic vacuum-suction covers for round household
dishes has a monopoly that is protected by a utility patent. The market demand
curve for this product is estimated to be: – 25P where Q is the number of plate
covers per year and P is in dollars. Cost estimation processes have determined
that the firm’s cost function is represented by + 2500Q -0.25*Q2.
(i) What
is the profit-maximizing price and output level? Solve this algebraically for
equilibrium P and Q and also plot the MC, D and MR curves and illustrate the
equilibrium point.
(ii) What
profit do you expect that the firm will make in the first year?
(iii) Do
you expect this profit level to continue in subsequent years? Why or why not?
2.
Greener Grass Company (GGC) competes with its main rival, Better Lawns and
Gardens (BLG), in the supply and installation of in-ground lawn watering
systems in the wealthy western suburbs of a major east-coast city. Last year,
GGC’s price for the typical lawn system was $1,995 compared with BLG’s price of
$2,100. GGC installed 9,130 systems, or about 55% of total sales and BLG
installed the rest. (No doubt many additional systems were installed by
do-it-yourself homeowners since the parts are readily available at hardware
stores.)
GGC has
substantial excess capacity—it could easily install 25,000 systems annually, as
it has all the necessary equipment and can easily hire and train installers.
Accordingly, GGC is considering expansion into the eastern suburbs, where the
homeowners are less wealthy. In past years, both GGC and BLG have installed
several hundred systems in the eastern suburbs but generally their sales
efforts are met with the response that the systems are too expensive. GGC has
hired you to recommend a pricing strategy for both the western and east¬ern
suburb markets for this coming season. You have estimated two distinct demand
functions, as follows:
Qw
=1,035.548 - 6.07164Pgw + 2.83Pbw + 2,100Ag - 1,500Ab + 0.2348Yw
for the
western market and
Qe =
49,714.29 - 30.7692Pge + 6.984Pbe + 1,180Ag - 950Ab + 0.0825Ye
for the
eastern market, where Q refers to the number of units sold; P refers to price
level; A refers to advertising budgets of the firms (in millions); Y refers to
average disposable income levels of the potential customers; the subscripts w
and e refer to the western and eastern markets, respectively; and the
subscripts g and b refer to GGC and BLG, respectively. GGC expects to spend
$1.5 million on advertising this coming year and expects BLG to spend $1.2
million on advertising. The average household disposable income is $55,000 in
the western suburbs and $25,000 in the eastern suburbs. GGC does not expect BLG
to change its price from last year, since it has already distributed its glossy
brochures (with the $2,100 price stated) in both suburbs, and its TV commercial
has already been produced. GGC’s cost structure has been estimated as TVC 5
755.363Q 1 0.005Q2 where Q represents single lawn watering systems.
a. Derive
the demand curves for GGC’s product in each market.
b. Plot
graphically the demand and MR curves for each market, and also show GGC’s
combined marginal revenue curve (MR) and its MC curve. Show graphically the
quantities that should be produced and sold, and the prices that should be
charged, in each market.
c.
Confirm your quantity and price results algebraically.
d.
Calculate the price elasticities of demand in each market and discuss these in
relation to the prices to be charged in each market.
e. Add a
short note to GGC management outlining any reservations and qualifications you
may have concerning your price recommendations.
Week 5
Good Will in Price Bidding. Sometimes, a bidder on a
work contract may bid lower than what would maximize his/her profit from the
contract and the reason for that is to create goodwill (to increase expected
future business from the buyer). How would you value the goodwill that is
obtained in this way?
New Product Introduction. Bayer Schering Pharma AG,
Germany owns the Alka-Seltzer, which was launched in 1931 and was meant for
relief of minor aches, pains, inflammation, fever, headache, heartburn, sour
stomach, indigestion, and hangovers. The Alka-Seltzer Plus was a spin-off of
the original medicine, meant to relieve colds and flu.
The
company has recently introduced a new and improved Alka-Seltzer Plus, as
described in the TV ad: “The Cold Truth”, (please, watch the ad listed in the
Required Readings)
The ad
shows that Alka-Seltzer Plus fights cough, body aches, runny nose, sneezing and
fever, just like Vicks NyQuil does, but it also now can fight congestion,
unlike NyQuil.
Explain
how the new Alka-Seltzer Plus has been quality- and price-positioned in an
existing market. In your opinion, has Bayer positioned their product
appropriately in the market for cold and flu symptoms relief products? Would
you advise Bayer to use a skimming or a penetration pricing strategy? Explain
your reasoning.
How do
you think Proctor and Gamble, the company who produces Vicks NyQuil,would
respond to the ad?
Price Quotes and Pricing Decisions Applied Problems. Please,
complete the following 3 applied problems in a Word or Excel document. Show all
your calculations and explain your results. Submit your assignment in the drop
box by using the Assignment Submission button.
Maxim
Motronics A.G. have been marketing a new product in Europe that has achieved
notable market success and it now plans to introduce this product into the United
States market. The product is an electronic device that is mounted in the rear
window of passenger cars and allows the driver of one vehicle to have a spoken
message converted to text and scrolled across the display panel to be read by
occupants of a following vehicle. This new product can utilize the hands-free
telephone microphone already installed in many new vehicles, or provides this
as free accessory. Maxim expects that demand will be slow at first but will
pick up quickly as automobile accessory stores begin to stock the product and
as word-of-mouth promotion spreads awareness. Maxim also plans to produce a
humorous video for posting to YouTube and to utilize social-media marketing to
spread awareness and enthusiasm for the new product. Market demand estimates
provided by Maxim are that the firm expects to sell about 125,000 units into
the U.S. market within 24 months, and that sales per month will start slowly
and increase monthly in the expected diffusion pattern until they stabilize at
about 10,000 per month after month 24. The diffusion curve parameters that fit
these assumptions are shown in the equation + 46.11T2 – 1.352T3, where Q is
sales per month and T is the number of months after the launch into the US
market. Maxim’s average variable cost (AVC) is constant at $62 per unit and he
expects to set the profit-maximizing price by applying a 167% mark-up to arrive
at his regular price of $165, since he estimates the demand curve to be –
0.02Q.
a. What
introductory price do you recommend Maxim sets for the launch of the product
into the US market, and why? (State any assumptions you need to make).
b. How
might he further adjust the price before raising it to the regular level he
envisions? (Again, state any assumptions you need to make.)
c. What
is your advice for Maxim concerning the confirmation of his prior projections
of demand and the shape of the diffusion curve, and the profit-maximizing
price, after this new product gains some months of experience in the U.S.
market?
2. Your
company, Bright Paints, is one of a dozen companies manufacturing a special
reflective paint used for traffic signs. The State Department of Transportation
has called for tenders to supply 10,000 gallons of blue reflective paint to be
delivered within two months. You can foresee fitting in a production run of the
blue paint and have decided to bid on the job. You calculate your incremental
costs for this job to be $76,200. This particular contract is standard, similar
in all in respects to hundreds of contracts you have bid on over the past few
years. Your pricing policy has been to apply a mark-up to incremental costs to
arrive at the bid price. Your mark-up has been higher when you had plenty of
orders and lower when you had few or no orders to fulfill. You have assembled
data relating the mark-up rate used and the percentage of contracts won at each
mark-up rate, as follows.
a. Why
would your company have bid with a zero mark-up on some past tenders? Why
didn’t it win all of those contracts?
b. What
is the bid price that maximizes the expected contribution of the contract?
c. Why,
or why not, is the fixed-price mode of bidding likely to be the best one to use
for this contract?
3. In
calculating the incremental cost of a particular project, how would you treat
the possible future costs of a lawsuit that may occur as a result of this
project, where the cost of the lawsuit might range from $10,000 to $500,000
with an associated probability distribution?
Week 6
Game Theory and Strategic Behavior. Suppose
that GE is trying to prevent Maytag from entering the market for high
efficiency clothes dryers. Even though high efficiency dryers are more costly
to produce, they are also more profitable as they command sufficiently higher
prices from consumers. The following payoffs table shows the annual profits for
GE and Maytag for the advertising spending and entry decisions that they are
facing.
Based on
this information, can GE successfully prevent Maytag from entering this market
by increasing its advertising levels? What is the equilibrium outcome in this
game?
Suppose
that an analyst at GE is convinced that just a little bit more advertising by
GE, say another $2m, would be sufficient to deter enough customers from buying
Maytag, thus, yield less than $0 profits for Maytag in the event it enters.
Suppose that spending an extra $2m on advertising by GE will reduce its
expected profits by $1.5 m, regardless of whether Maytag enters or stays out.
Would this additional spending on advertising achieve the effect of deterring
Maytag from entering? Should GE pursue this option?
Sustainable Competitive Advantage.
Describe the circumstances under which a firm chooses a low-cost strategy to
attain sustainable competitive advantage. What about the situations when a
differentiation strategy is chosen? Provide specific real world examples.
Focus of the Final Paper
Research
a specific company of your choice and identify some of the managerial decisions
that were made over time and in response to changes in its market or
competitive environment. Use the Ashford University Online Library and
web-based sources for your research. At least three external scholarly sources
must be used. Address all of the following areas:
Describe
the company and provide a brief history of its operations. Find or use graphs
to illustrate its financial performance over the years.
Identify
any sources of risk or uncertainty in its operations. Do the financial reports
indicate risky or uncertain activities or changes to the economic environment
that ultimately appear to have affected the company’s financial outcomes? Be
specific.
Are there
any government regulations that have affected this company’s operations
domestically or abroad? Explain.
Describe
the inputs that are used in this company’s production function and identify any
challenges to securing these inputs.
Determine
if the company has introduced new products in existing markets or created new
markets over time. What is the impact on its finances?
Determine
if the price of its products increased or declined over time and analyze the
reasons for price fluctuations. Study the demand elasticity for its products
and discuss the availability of close substitutes for its products. How does
that affect pricing decisions?
Analyze
the company’s profitability. Identify the economy or industry influences on its
costs, operations, and profitability.
Describe
the competitive environment in which the firm operates, the distribution of
market power, and the strategic behavior of the firm and its competitors. Apply
your knowledge of the theory of this company’s market structure. How does the
company make pricing and production decisions? Is your observation supported by
the theoretical models? Refer to the financial reports for illustration.
Identify
any non-price competitive strategies that the company might be engaging in?
Provide specific examples.
Evaluate
if the company made any mistakes in its decisions over time, and recommend any
changes or improvements for the future operations. Refer to the financial
reports when making specific observations or recommendations.
Use
economic language and demonstrate your understanding of the concepts and
theories of this course.