Production Operation Assignment

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Assignment 6: PRICING
a) Computation of Economic Value of an offering
Mercedes Benz is launching its luxury SUV (called the CDL class) in a market dominated by Lexus GL. The CDL class uses diesel and obtains 25 miles per gallon. The Lexus model, priced at $48000, uses premium gasolene and obtains 20 miles per gallon. Both the models need to be serviced annually but the CDL being a diesel engine requires annual service that is costlier by $100. The life of a diesel engine is typically longer – hence the residual value of a 10 year old CDL is estimated to be $1600 higher than the Lexus. Assume (i) the average cost of premium gasolene to be $3.00 per gallon (ii) the average cost of diesel to be $3.25 per gallon (ii) the average customer drives 12000 miles per year and (iii) there is no time discount. What should be the price of the CDL such that the economic value of Benz CDL over Lexus GL (during a 10 year use horizon by a customer) is completely appropriated by Mercedes Benz? The economic value of CDL:

Price of substitute=48000
Cost saving=(12000/20*3-12000/25*3.25-100)=140
Revenue enhancing=residual value=1600+residual value of GL
Use horizon=10
EV of CDL=48000+140*10+1600+residual value of GL=51000+residual value of GL The economic value of GL:
Price of substitute=X
Cost saving=(12000/25*3.25-12000/20*3+100)=-140
Revenue enhancing=residual value=residual value of GL
Use horizon=10
EV of GL=X+(-140)*10+ residual value of GL=X-1400+residual value of GL To make (51000+residual value) equal (X-1400+residual value of GL) X should be 52400
So the price of CDL should be lower than 52400 dollars such that the EV of CDL is higher than GL. b) Breakeven Analysis
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