Question

Suppose the farm equipment manufacturer from the previous question was able to charge $30,000 per tractor, and produces and sells 2,000 tractors per year at that price. As a reminder, the company originally spent $3 million in research and development costs. The company now spends $20 million at the beginning of each year to rent a factory, and $10,000 per tractor in materials and wages. If another manufacturer enters the market in the middle of a year and engages the company in a price war, what is the lowest price the company would be willing to charge for each tractor?

Answer 1

Given Information:

Rent = $20,000,000

Materials and Wages = $10,000/tractor

Number of tractors = 2,000

Amount spent on R&D = $3 million

Required Information:

Lowest price to sell a tractor = ?

Answer:

Lowest price to sell a tractor = at least $20,000

Calculations & Explanation:

The company needs to sell at least at a price that all of its manufacturing cost can be recovered without the profit margin.

This happens at a break-even point where total revenue equals the total manufacturing cost.

Total manufacturing cost = Total revenue

The revenue is number of tractors multiplied by some price x

Total revenue = 2,000*x

Total manufacturing cost = fixed cost + Variable cost

Total manufacturing cost = 20,000,000 + 2,000(10,000)

Total manufacturing cost = 20,000,000 + 20,000,000

Total manufacturing cost = 40,000,000

so,

Total manufacturing cost = Total revenue

40,000,000 = 2,000*x

x = 40,000,000/2,000

x = $20,000

Therefore, the lowest price to sell each tractor should be atleast $20,000

Note: The R&D cost is not usually included in such scenarios because R&D cost is sunk and should not be added in these calculations.