Question

Consulting the senior foreman at the central depot, the management learned with about $2.3Mn investment in additional equipment MIS can also provide three basic services at the warehouse to generate additional income. These basic services apply to other machinery used on sites, are not as extensive as and do not interfere with the drill unit repairs done at the central depot. Details of these services are summarized in the following table:

Service Type	Projected demand	Price per Service	Cost per Service
Type 1	200	$2,500	$1,500
Type 2	200	$6,000	$2,000
Type 3	400	$20,000	$8,000

The management predicts that with 25% discount in the price of Type 3 service, they can increase their type 3 service business by 200%, but to meet the increased demand they would need to hire ten licenced mechanics at a monthly salary of $40,000.  

Do you approve of hiring licensed mechanics for warehouse-based basic services at a monthly salary of $40,000? Why or why not?

Answer 1

Current profit of Type 3 service = Total Revenue - Total Cost

Current profit of Type 3 service = Price per service * Projected Demand - Cost per service * Projected Demand

Current profit of Type 3 service = $20000*400 - $8000*400 = $4,800,000

Now with 25% discount, new price for Type 3 will be $20000*(1-0.25)= $15,000

With this, demand for Type 3 will increase by 200% i.e. new demand = 400*(1+2.00)= 1200

Additional cost of hiring 10 licensed mechanics = Monthly salary * number of mechanics = $40,000*10 = $400,000

New expected profit of Type 3 service = New Price per service * New Projected Demand - New Cost per service * New Projected Demand

New expected profit of Type 3 service = $15,000*1200 - ($8000*1200+$400,000) = $8,000,000

Hence with new setup the profit is expected to increase from $4,800,000 to $8,000,000.

Hence, the approval of hiring licensed mechanics for warehouse-based basic services will make economic sense. Yes it should be approved.

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