Question

A company selling air-filtration systems is trying to evaluate the true economic value of its systems for an off-shore oil rig. The price of the “next-best alternative” is $80,000 Your new product (no price on it yet) has a 2% chance of a system crash and operating costs of $18 per hour. The “next-best alternative” has a 23% chance of system crash and lower operating system costs of $12 per hour. The cost of a crash is $350,000. Annual operation is 2500 hours. The system will only be used for one year and have no salvage value.

a) Calculate the true economic value. Show your work (the equation and what you plugged in) to demonstrate you know how to calculate and to get partial credit if your final answer is wrong.

b) What two pieces of information would you need to determine the customer’s incentive to purchase?

c) What two pieces of information would you need to determine the firm’s incentive to sell?

Answer 1

a) TRUE ECONOMIC VALUE=Cost of next best alternative+value of performance differential.

Cost of next best alternative is the cost of comparable product offered by other company.

Value of Performance differential is the Value of additional features provided by the seller of a product. It can be superior(positive) and inferior(negative) in some dimensions.

Calculation of True economy value:

Particulars Amount

Cost of next best alternative(A)   80000

Value of Performance differential

​​​​​Extra System crash cost(350000*[2%-23%] or [-21%] -73500

Saving in Operating Cost(2500 hours*[18-12]or 6 15000

Value of performance differential (B) -58500

TRUE ECONOMIC VALUE (A+B) (80000+[-58500]) 21500

b) Two pieces of information we need to determine the customer’s incentive to purchase are as follows:

1. Design a Pricing Strategy that creates incentive to customer to purchase.

2. Design a Promotion program to convey the value of product to customers.

c) Two pieces of information we need to determine the firm’s incentive to sell are as follows:

1.Design a Pricing Strategy that creates incentive to seller to sell.

2.Choosing the Right distribution channel through which seller can transfer the product to the customer.

PLEASE UPVOTE IF YOU FIND THE SOLUTION HELPFUL.