Question

Smyth Industries operated as a monopolist for the past several years, earning annual profits amounting to $54 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 $18 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 $2 billion. Ignoring antitrust concerns, , compute the present value of Smyth Industries' profits if it remains a duopolist in this market when the interest rate is 0.1. Round all calculations to 3 decimals

Answer 1

SOlution:

Annual profit in monopolistic condition	$54	million
Annual profit in case of competition	$18	million
Cost of new pricing policy	$2,000	million		(2 billion)
Increase in annual cash flow per year in perpetuity	$36	million		(54-18) million
Interest rate (10%)	0.1
Present Value of annual cash flow of $36 million in perpetuity at interest rate 0.1	$360	million		(36/0.1)
NET PRESENT VALUE OF PROFITS(2000-360)	$1640	million