Consider the following information for Aokay breakfast cereal: Aokay is considering investing in a Gluten Extraction Machine to produce gluten-free cereal. The firm that manufactures the machine has a lot of market power. They insist that your firm pay upfront $150 in the year 2017 and your order will be filled one year later in 2018. Once operational, in 2018, all Aokay cereal boxes will be branded “gluten-free” and this is expected to increase demand 25% for the year 2018. However, by 2019 demand will revert to normal.
Demand for Aokay without the “Gluten-Free” brand: Q = 800 – 200P
Cost function for Aokay: TC = 400 + 0.2Q
A. Calculate profit for 2018 assuming it does NOT buy the machine.
B. Calculate the profit for 2018 assuming your firm does buy the machine. Then calculate the difference in profit for 2018.
C. Assume that the Aokay’s discount rate is 15%. Calculate the Present Value of the difference in profit. Should Aokay invest in the machine?