Teddy Bower sources a parka from an Asian supplier for $10 each and sells them t

Question

Teddy Bower sources a parka from an Asian supplier for $10 each and sells them to customers for $22 each. Leftover parkas at the end of the season have no salvage value.

The demand forecast is normally distributed with average 2,100 parka and standard deviation 1,200 parka.

Now Teddy Bower found a reliable vendor in the United States that can produce parkas very quickly but at a higher price than Teddy Bower’s Asian supplier. Hence, in addition to parkas from Asia, Teddy Bower can buy an unlimited quantity of additional parkas from this American vendor at $15 each after the season demand is known.

If Teddy Bower uses both its Asian and American suppliers correctly, what is its expected mismatch cost?

Explanation / Answer

The right answer is $9500

Teddy sources from Asian supplier for $10 and sells at $22. Hence the profit is $12

Teddy can buy unlimited from american suppliers at $15. Hence the profit in this case is $7

Expected mismatch in cost = (15*2100 - 10*2100) - (2100 - 1200) = $9500

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