Managerial Finance
Review Test Submission: PROBLEM SET #3Question 120 out of 20 pointsPeter Higgins is a sales agent for XZY Company. He has an effort cost function of C = e2 and a reservation wage of $1,500. His wage package is W = 1,500 + 0.2Q where the CEO sets the incentive at 0.2 and Q = 200e. Q is the output. If the CEO increases the incentive from 0.2 to 0.25, what happens to the Peters effort? Will profits rise or fall? Selected Answer: Compensation = W0 + BQSolving under lower incentive Solving under the higher incentive1,500 + 0.2Q 1,500 + 0.25Q1,500 + .2(200e + u) 1,500 + .25(200e + u)1,500 + .2(200) 1,500 + .25(200)1,500 + 40 1,500 + 50Compensation function: $1,500 + 40e Compensation function:1,500 + 50eEmployee’s cost function: e2 Employee’s cost function: e2
Expected compensation is $2,300 Expected compensation is $2,750Expected output Q = 200(20)= $4,000 Expected output Q = 200(25) =5,000Expected profit = $1,700 Expected profit = $2,250 Peter’s effort will increase based on incentive and increase in his utility.Expected profit will raise in this case to $2,250Question 220 out of 20 pointsGreat Cars, Inc. faces the following demand function for its automobiles:P = 55,000 – 200 QIts marginal cost (MC) is $9,000. What will its price be if it decides to sell the automobiles by itself and what will the price be if it sells though DistriCorp, an independent distributor. Note that when Great Cars, Inc. contracts with DistriCorp, it has to take into account that DistriCorp faces the same demand curve. What is the consequence of this exclusive dealing on prices? Selected Answer: MR = MCP = 55,000 – 200 Q55,000 – 400 Q = 9,00055,000 – 9,000 = 400 QQ = 46,000/400Q = 115 automobiles