If the Rhine Company ignores the possibility that other firms may enter its mark
ID: 1208396 • Letter: I
Question
If the Rhine Company ignores the possibility that other firms may enter its market, it should set a price of $10,000 for its product, which is a power tool. But, if it does so, other firms will begin to enter the market. During the next two years, it will earn $4 million per year, but in the following the next two years, it will earn $1 million per year. On the other hand, if it sets a price of $7,000, it will earn $2.5 million in each of the next four years, since no entrants will appear. a. If the interest rate is 10 percent, should the Rhine Company set a price of $7,000 or $10,000? Why? (Consider only the next four years) b. If the interest rate is 8 percent, should the Rhine Company set a price of $7,000 or $10,000? Why? (Consider only the next four years) c. The results in parts a and b pertain to only the next four years. How can the firm's manager extend the planning horizon?Explanation / Answer
First case: 10 %
In first option, his total earning is 4M (1.1)^3 +4M (1.1)^2 + 1M (1.1) + 1M = 12.264M
Second option
His total earning is 2.5M (1.1^3) + 2.5M (1.1^2) + 2.5M (1.1) + 2.5M = 11.6025M
Second case 7 %
In first option, his total earning is 4M (1.07)^3 +4M (1.07)^2 + 1M (1.07) + 1M = 11.549772M
Second option
His total earning is 2.5M (1.07^3) + 2.5M (1.07^2) + 2.5M (1.07) + 2.5M = 11.0998575M
In both the cases the firm will set $10000 as price.
The result biased because of monopoly price in first four year that is very high but considering the after 4 year period the manager should choose 7000 as price because there is no much change and the future is secure.
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