Baker Enterprises operates a midsized company that specializes in the production

Question

Baker Enterprises operates a midsized company that specializes in the production of a unique type of memory chip. It is currently the only firm in the market, and it earns $10 million per year by charging a higher price of $115 per chip. Baker is concerned that a new firm might soon attempt to clone its product. If successful, this would reduce Baker’s profit to $4 million per year. Estimates indicate that, if Baker lowers its price to $90 per chip, the entrant will stay out of the market and Baker will earn profits of $5 million per year for the indefinite future.

a. Does it make sense for Baker to limit price if the interest rate is 10 percent?

b. What is the lowest amount of profit Baker would need when limit pricing to make this strategy profitable?

Explanation / Answer

a) It wont make sense for Baker to limit price if the interest rate is 10 percent.

b) Profits = Selling Price per Unit x Unit Sales - Variable Costs per Unit x Unit Sales - Fixed Costs

Fixed Cost = 1,000,000 ( 1 million )

Veriable cost = 115 - 90 = 25

we can calculate how many units should be sold to generate $4 Million in profits for Friends Company

Unit of Sales = Fixed Cost + profit / Selling price per unit - veriable cost

= 1,000,000 + 4,000,000 / 115 - 25 = 55,555

The same formula can be used when the target profit is $5 Million:

= 1,000,000 + 5,000,000 / 115 - 25 = 66,666

We can check our answers for the desired $4 Million and $5 Million profits by using the same formula we applied before:

Profits = Selling Price per Unit x Unit Sales - Variable Costs per Unit x Unit Sales - Fixed Costs

For the 55,555 units sold, the profits will be calculated as follows:

Profits = $115 x 55,555 - $25 x 55,555 - $1000,000 = 3,999,950 ( 3.9 Million )

And for the 66,666 units sold, the profits can be determined as shown below:

Profits = $115 x 66,666 - $25 x 66,666 - $1000,000 = 4,999,940 ( 4.9 Million )

Lowest Amount of Profit Baker is 3.9 Million , this profit to Baker would need when limit pricing to make this strategy profitable

The first generic strategy, overall cost leadership, can enable a company to earn above average profits despite the presence of strong competitive pressures. But it can also be difficult to implement. In a company pursuing a low-cost strategy, every activity of the organization must be examined with respect to cost. a low-cost strategy—like any other strategy—also involves risks.

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