A supplier of metal aluminum serving a Coca-Cola bottler in a large country in L

Question

A supplier of metal aluminum serving a Coca-Cola bottler in a large country in Latin America builds a plant along with associated production equipment at an annualized investment cost of $20 million per year. The plant is located directly next to the Coca- Cola bottler's bottling factory, which economizes on transportation costs. The marginal cost of producing a can is $0.20 per can. Under a proposed contract, Coca-Cola will pay the supplier $0.50 per can to produce 100 million cans per year. However, if the can supplier does not sell cans to the Coca-Cola bottler, its best available alternative is to sell cans to a Pepsi bottler. The Pepsi bottler would pay the same price for cans that Coca- Cola would pay and would buy the same number of cans. Even though the Pepsi bottler is the closest bottling operation to Coca-Cola's, it is located nearly 1,000 miles away, which makes the marginal cost to the can company of selling to Pepsi $0.26 per can (a) Is there a relationship-specific investment in this case? (b) What is the can producer's rent under the contract with Coca-Cola? (c) What is the can producer's quasi-rent? (d) Suppose the Coca-Cola bottler and the can producer sign a contract at the price of $0.50 per can, but then the Coca- la bottler attempts to hold up the can producer. What is the smallest price the can producer would be prepared to accept from the Coca-Cola bottler? (e) Can the can producer hold up the Coca-Cola bottler in this case?

Explanation / Answer

PART-A) Yes, in the current scenario there a relationship-specific investment because the can company loses value if deployed in its next best use (Pepsi). With the usage of the asset in its next best use (Pepsi) instead of its best use (Coca-Cola) there will be a profit loss because marginal costs for producing cans rises from $0.20 per can to $0.26 per can at Pepsi.

PART-B) I = $20 million, C= $.20, P= $.50, produce 100 million cans per year

Rent = 100 million (0.5 - 0.2) - 20 million

       = $10 million per year

PART-C)

Coke RSI = 100 million (0.5 - 0.2) = $30 million

Pepsi RSI = 100 million (0.5 - 0.26) = $24 million

Producer's quasi-rent = $30 million - $24 million = $6 million

PART-D)

$20,000,000 = 100,000,000 (x-.2); It gives Pm-.2= .2; or Pm = .4

Hence the smallest price the can producer would be prepared for accepting from Coca-cola equals $0.40 because otherwise it's not break-even.

PART-E)

Coca-Cola could assert that in one way or another considering the facts that the contract is proposed and not signed. The company may claim that the cost of raw materials (i.e. bottles) have increased and therefore sharply curtailed production or claim quality of bottles have gone done and hence failed to deliver the promised quality

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.