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Sample case study ,

Question 1
Maggie runs a small independent bookshop. She pays a lease of \$20,000 per year. Each year, she earns revenues of \$100,000, and her cost of goods (and other operating expenses) is \$10,000 per year.
If she were not running the store, she would instead work in a local bookshop and earn a salary of \$40,000 per year.
It is currently the beginning of 2014. She has not yet paid any of her expenses for 2014.
She learns that in one year’s time (at the beginning of 2015), the lease on the store will increase and so it will no longer be profitable for her to run the store. The store will have no value at that time.

At the beginning of 2014, a potential buyer (Buyer A) approaches Maggie, and would like to negotiate over a possible sale of the store. Maggie sits down and works out her Willingness-to-Sell (WTS) in order to negotiate effectively.
a)     (2 marks) What is her Willingness -to-Sell for the store? That is, what is the price that would make her indifferent between selling and not selling?
b)     (1 mark)Now suppose Maggie has already paid her rent up -
front for the next year, and cannot get the money refunded. However, she can allow buyer A to run a bookshop on the premises. There are no other sublet options. What is her WTS
for the store and premises?

©              (1 mark) (Back to original scenario; ignore b.) Maggie has not yet signed the lease. However, now suppose that Maggie faces uncertainty about her cost of goods. She thinks that there is a 50% chance that her cost of goods in 2014 will be \$10,000 and there is a 50% chance that her cost of goods will be \$20,000.Assuming that Maggie is risk -neutral, what is her WTS for the store?

(d) (3 marks) (Back to original scenario; ignore b and c.) Maggie finds out that she will get another offer (from Buyer B) for the store next week. She thinks that there is a 50% chance that she will receive a final offer of \$20,000 and a 50% chance that she will receive a final offer of \$40,000.She has to accept or reject buyer A before she learns the details of the offer (B) next week. What is her
Willingness –to -Sell the store to potential buyer A?. (Warning: this question is tricky! You need to ask yourself whether Maggie has any choices that you are not considering.)
e)(1 mark) (Back to original scenario; ignore b and c and d.) Suppose that Maggie also values being her own boss. Specifically, she earns \$10,000 a year in utility from being her own boss. What is her WTS?

Question 2
A car manufacturing firm, Tesla Motors, is considering expanding its factory to meet increasing demand. It rents the factory and machinery used to produce its cars and the lease on its existing factory expires in 1 month.Tesla Motors’s current factory allows it to produce 10 cars each day at a cost of \$23,500 per car. If it chooses to move location to a larger factory, Tesla Motors will double its output but have to pay additional rent on the factory equivalent to \$10,000 per day. It would also have to rent more machinery which would cost an additional \$200 per car. All other costs will remain unchanged.
If it moves to the larger factory, Tesla Motors would have the option to upgrade all of its machinery to the latest, most efficient models; in that case it would not need to rent the \$200 machinery, but its total machinery costs would be higher. Combined with the larger factory, this will allow Tesla Motors to triple production. It is still waiting for a quote on the additional machinery cost. Assume that regardless of how many cars Tesla Motors produces they will all be sold immediately for \$25,000 and that Tesla Motors only makes decisions based on what will be most profitable in 1 months’ time.

a) (1mark ) If the upgraded machinery rental costs \$650 per car more than Tesla Motors’s present machinery rental costs, what will Tesla Motors do?
-Stay in its existing factory
-Move to the new factory but keep existing machines
-Move to the new factory and upgrade its machines

b) (3 marks) If instead the company providing the upgraded machinery is negotiating with Tesla Motors, what is Tesla Motors’s willingness to pay (per day) for the machinery upgrade?You may answer in per -car terms, or as a lump sum payment for the machinery

Question 3
(8 marks)
The Khazak Gold owns a rail line from the town of “Isolated” to the coastal port of “Dibri.” It cost them \$20 million to build the rail line in 2007. It is now 2014. The  Patong Company has discovered gold deposits near Isolated that they want to export overseas. There are almost 20,000 ounces of gold in the mine. The current price of gold is \$400 per ounce and it is expected to remain at that level over the life of the mine.

PATONG COMPANY want to transport the gold to the port using Khazak Gold Dibri-Isolated rail line.From  Dibri, PATONG COMPANY will ship the gold to their overseas buyers. They have no alternative transportation substitutes available.

(a)(3 marks) Suppose that it costs KHAZAK GOLD  \$5 per ounce to transport the gold from Isolated to Dibri. They have free capacity on the line. It costs PATONG COMPANY \$10 per ounce in shipping from Dibri to their overseas buyers. It will cost PATONG COMPANY \$1 million to make the mine operational and \$100 to extract each ounce of gold.KHAZAK GOLD  and PATONG COMPANY negotiate over the rail freight charge per ounce for PATONG COMPANY’s gold,
before the mine is made operational. What is PATONG COMPANY’s Willingness -to-Pay for transport of gold, as a lump -sum payment? What is Khazak Gold Willingness-to-Sell, as a lump-sum payment? What is the negotiated payment likely to be?

Note: If you find it more intuitive, you can work out WTP and WTS as a per-ounce price; but it’s important to remember that the parties agree on both (1) the quantity to be transported and (2) the total lump-sum to be paid. In some other applications that will be important.

(b)(4 marks) Now suppose that PATONG COMPANY can build an airport close to Isolated for \$2 million and purchase a cargo plane for \$500,000 that could ship the gold straight to its overseas buyers for \$25 per ounce. Does this affect WTP or WTS? What are the new values of WTP and WTS?What is the negotiated payment likely to be?

(c)(1 mark) Is it likely that PATONG COMPANY will build the airport? To answer, think about what role the airport played in part (b) of the question

B M S 345. Case Study I

• Clinical applications
• basic sciences taught concurrently
• fall semester of the first year curriculum
• veterinary medicine