The best course of action for the firm would be to sell the production facility at $2 million, because in order to to continue doing business in the next two years, the costs to operate will be greater than the potential profits expected by the company. By the end of four years, company will have already spent $16.5M, vs. the total anticipated return of $14M. With this in mind, the company will have lost $2.5M by the end of four years. In addition, the plant will have no resale value by the end of four years, and will not be able to recoup the additional losses incurred.
On the other hand, if the company drops the product, the company will be able earn a profit of $8M ($6M 2yr profit + $2M production facility) and mitigate the risk by -500k, …show more content…
An example of this would be supplying the dressing or sauce for new product of a restaurant or fast-food chain. Although this is poised as an opportunity for growth, this has been a risky source of growth for the company, as compared to offering existing products. Over the years, these projects have not been able to reap the expected sales potential. A menu offering may not fly with the market hence the customer may even choose to discontinue the product shortly after it’s launch. Often times, companies may terminate after a one-year contract in favor of a lower-priced competitor or even invest in their own machinery cut down supplier costs. The sunk-cost fallacy in this scenario is while individuals aspire to seek more profits for the company, in order to create a customized SKU, the company has to spend time and resource on sunk costs such as: R&D, production and marketing. These costs will no longer be recovered by the company regardless of the product’s success or …show more content…
This case can be resolved by utilizing marginal analysis. According to Froeb, firms should sell more if marginal revenue is greater than marginal cost, and sell less if marginal revenue is less than marginal cost (Froeb, L. 2016). Moreover, if marginal revenue is equal to marginal costs, the firm is selling at the right amount (Froeb, L. 2016). If marginal costs are less than revenue, then the firm should sell more units at a reduced price, with the probability of earning more, given an expected increase in volume. On the the other hand, if costs are marginal costs are greater than revenue, the company should increase prices to make up for the costs and earn more money on each
On the other hand, if the company drops the product, the company will be able earn a profit of $8M ($6M 2yr profit + $2M production facility) and mitigate the risk by -500k, …show more content…
An example of this would be supplying the dressing or sauce for new product of a restaurant or fast-food chain. Although this is poised as an opportunity for growth, this has been a risky source of growth for the company, as compared to offering existing products. Over the years, these projects have not been able to reap the expected sales potential. A menu offering may not fly with the market hence the customer may even choose to discontinue the product shortly after it’s launch. Often times, companies may terminate after a one-year contract in favor of a lower-priced competitor or even invest in their own machinery cut down supplier costs. The sunk-cost fallacy in this scenario is while individuals aspire to seek more profits for the company, in order to create a customized SKU, the company has to spend time and resource on sunk costs such as: R&D, production and marketing. These costs will no longer be recovered by the company regardless of the product’s success or …show more content…
This case can be resolved by utilizing marginal analysis. According to Froeb, firms should sell more if marginal revenue is greater than marginal cost, and sell less if marginal revenue is less than marginal cost (Froeb, L. 2016). Moreover, if marginal revenue is equal to marginal costs, the firm is selling at the right amount (Froeb, L. 2016). If marginal costs are less than revenue, then the firm should sell more units at a reduced price, with the probability of earning more, given an expected increase in volume. On the the other hand, if costs are marginal costs are greater than revenue, the company should increase prices to make up for the costs and earn more money on each