Smyth Industries operated as a monopolist for the past several years, earning an

Question

Smyth Industries operated as a monopolist for the past several years, earning annual profits amounting to $66 million, which it could have maintained if Jones Incorporated did not enter the market. The result of this increased competition is lower prices and lower profits; Smyth Industries now earns $11 million annually. The managers of Smyth Industries are trying to devise a plan to drive Jones Incorporated out of the market so Smyth can regain its monopoly position (and profit). One of Smyth's managers suggests pricing its product 50 percent below marginal cost for exactly one year. The estimated impact of such a move is a loss of $1 billion.

Ignoring antitrust concerns, compute the present value of Smyth Industries' profits, if it could have remained a monopoly when the interest rate was 0.06 .

Round all calculations to 3 decimals

Explanation / Answer

Annual profit in monopolistic condition $66 million Annual profit in case of competition $11 million Cost of new pricing policy $1,000 million Increase in annual cash flow per year in perpetuity $55 million (66-11) million Interest rate (6%)           0.06 Present Value of annual cash flow of $55 million in perpetuity at interest rate 0.06 $916.67 million (55/0.06) NET PRESENT VALUE OF PROFITS(1000-916.67) $83.33 million

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