## Sunday, January 12, 2020

### Production Operation Assignment

Assignment 6: PRICING a) Computation of Economic Value of an offering Mercedes Benz is launching its luxury SUV (called the CDL class) in a market dominated by Lexus GL. The CDL class uses diesel and obtains 25 miles per gallon. The Lexus model, priced at \$48000, uses premium gasolene and obtains 20 miles per gallon. Both the models need to be serviced annually but the CDL being a diesel engine requires annual service that is costlier by \$100. The life of a diesel engine is typically longer Ã¢â‚¬â€œ hence the residual value of a 10 year old CDL is estimated to be \$1600 higher than the Lexus. Assume (i) the average cost of premium gasolene to be \$3. 0 per gallon (ii) the average cost of diesel to be \$3. 25 per gallon (ii) the average customer drives 12000 miles per year and (iii) there is no time discount. What should be the price of the CDL such that the economic value of Benz CDL over Lexus GL (during a 10 year use horizon by a customer) is completely appropriated by Mercedes Benz? The economic value of CDL: Price of substitute=48000 Cost saving=(12000/20*3-12000/25*3. 25-100)=140 Revenue enhancing=residual value=1600+residual value of GL Use horizon=10 EV of CDL=48000+140*10+1600+residual value of GL=51000+residual value of GL The economic value of GL: Price of substitute=XCost saving=(12000/25*3. 25-12000/20*3+100)=-140 Revenue enhancing=residual value=residual value of GL Use horizon=10 EV of GL=X+(-140)*10+ residual value of GL=X-1400+residual value of GL To make (51000+residual value) equal (X-1400+residual value of GL) X should be 52400 So the price of CDL should be lower than 52400 dollars such that the EV of CDL is higher than GL. b) Breakeven Analysis Nokia has decided to manufacture a special edition cellphone called HiRide for the teen market next year that will be sold with SprintÃ¢â‚¬â„¢s wireless service. For this phone, NokiaÃ¢â‚¬â„¢s variable manufacturing cost is \$35 per phone.Fixed manufacturing costs amount to \$20 million and advertising cos ts are expected at \$6 million. Nokia will sell HiRide to retailers and pay its own salesmen a commission of \$8 per phone sold to the retailers. The retail price (i. e. , price paid by the end customer) of the product is \$120 and retail margin typically average about 10%. (i) What is the price at which Nokia sells to retailers? Assume that the price is X, thus: X*(1+10%)=120 X=\$109 (ii) What is NokiaÃ¢â‚¬â„¢s contribution per unit sales for HiRide? Contribution per unit= P-VC=109-(35+8)=\$66 (iii) What is NokiaÃ¢â‚¬â„¢s breakeven volume?BE volume=FC/contribution per unit=? (20000000+6000000)/66=393939. 4? 393940 (iv) NokiaÃ¢â‚¬â„¢s actual sales in Year 1 turned out to be 375000 units. Since the product did not break even, NokiaÃ¢â‚¬â„¢s product manager decided to reduce the commission offered to its salesmen in Year 2. Provided the sales volume, price, and other fixed costs remain the same as in Year 1, how much should be the new commission so that HiRide breaks even in Year 2? Assume that it is X, thus: The new contribution per unit would be 109-(35+X), which equals 74-X BE volume =375000=FC/ new contribution per unit=26000000/(74-X) So X =4. 76\$