A risk-neutral firm sells camera. Lenses price varies from year to year, which m

Question

A risk-neutral firm sells camera. Lenses price varies from year to year, which makes them to think about making their own lenses. They sell cameras $300 each. Labor and other inputs (except lenses) cost for every camera is $200. The firm has 100,000 confirmed orders during the next year. It has two options: Lenses from the market: (case 1) $120 or (case 2) $80 or (case 3) $40 Making: (Case 4) Purchasing a lenses factory using a bank loan that entails an annual payment of $7,000,000. Moreover, producing the finished lenses per one camera costs $10. a) Determine whether this firm prefers to make or to buy. b) Assume that this firm does not have enough cash to cover its loss and will go bankrupt, if lenses price is high (i.e. $120). Moreover, it is committed to continue being an ongoing business during next year. If the firm can get a loan this year at %10 interest rate (while it is able to lend at %10 interest rate), what shall it do if Case 3 is more likely than Case 1? (For instance case 1 with 0.2 prob., case 2 with 0.3 prob., and case 3 with 0.5 prob.) what shall it do if Case 3 is less likely than Case 1? c) The firm can get a loan this year at %r interest rate, and lend at %10 interest rate. What is the maximum value of r for which the firm will choose to buy from the market firms, if we know that case 1 has 0.2 prob., case 2 has 0.3 prob., and case 3 has 0.5 prob.

Explanation / Answer

Buying Per camera Case 1 Case2 Case 3 Case 4-Making Selling price 300 300 300 300 Costs: Labor &other inputs 200 200 200 200 Lens cost 120 80 40 10 Int. exp.7000000*10%/100000((saved)/spent -7 -7 -7 7 Net costs/camera 313 273 233 217 Contribution(S.P- Net Costs)/camera -13 27 67 83 a.. Firm will prefer to make as contribution /camera is highest ,in this option. b.. if Case 3 is more likely than Case 1? (For instance case 1 with 0.2 prob., case 2 with 0.3 prob., and case 3 with 0.5 prob.) ie.cost of lens will be: Most probable cost of the lens will be (120*0.2)+(80*0.3)+(40*0.5)= 68 Buying Per camera Probable case Case 4-Making Selling price 300 300 Costs: Labor &other inputs 200 200 Lens cost 68 10 Int. exp.7000000*10%/100000((saved)/spent -7 7 Net costs/camera 261 217 Contribution(S.P- Net Costs)/camera 39 83 Still the firm will prefer to make if Case1 is more likely than Case 3? (For instance case 1 with 0.5 prob., case 2 with 0.3 prob., and case 3 with 0.2 prob.) ie.cost of lens will be: Most probable cost of the lens will be (120*0.5)+(80*0.3)+(40*0.2)= 92 Buying Per camera Probable case Case 4-Making Selling price 300 300 Costs: Labor &other inputs 200 200 Lens cost 92 10 Int. exp.7000000*10%/100000((saved)/spent -7 7 Net costs/camera 285 217 Contribution(S.P- Net Costs)/camera 15 83 Making will be preferred c. Buying Per camera Probable case Case 4-Making Selling price 300 300 Costs: Labor &other inputs 200 200 Lens cost 68 10 Int. exp.7000000*10%/100000((saved)/spent -7 7 Net costs/camera 261 217 Contribution(S.P- Net Costs)/camera 39 83 Cost of Labor &other inputs, being equal , Difference in costs in the above option=(261-217)= 44 out of which lens cost of the make option= 10 so, bal.towards int.cost= 34 So,rate of interest r% must be 7000000*r%/100000=34 r%=48.57% So, maximum value of r for which the firm will choose to buy from the market firms= 48.57% Until then, it will only prefer to make.

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