Question

The investors of Smith Autos have put up $500,000 to construct a building and purchase all equipment required to wash cars. The investors expect to earn a minimum return of 10% on their investment. If the money to set up the business had been borrowed from a bank instead, the car wash owners would have paid a 10% interest rate. The car wash is open 50 weeks per year and washes 800 cars per week. Whether operative or not, the company must pay $1,000 per week return to investors and $1,000 per week as insurance. The variable costs for the 800 weekly washes includes $1,000 labour cost and $600 materials cost. There are many car washes of equal quality and service in the area and they charge $1.5 per car wash. A. Based on your knowledge of the different forms of market structure, do you think Smith Autos should stay in business? Show calculations B. Graphically represent the company's performance, showing profit or loss. C. Another car wash company operates inside a gated community in the vicinity and offers its services at $6 per wash under a licensed agreement. Highlight how is it possible for this company to charge a higher price than the market and still stay in business. D. After a few mouths, due to the forces of demand and supply, the market price is pushed down to $1.5 per car wash. What course of action will you suggest to Smith Autos?

Answer 1

A. No, as the company incurs a weekly loss of $2,400, making it financially unviable.

B. The graph would be shows a downward slope indicating a loss with fixed revenue at $1,200 and total costs at $3,600 per week.

C. The exclusivity of the gated community allows the car wash to charge a premium due to limited competition and potentially higher perceived value.

D. Smith Autos should consider cost reduction, efficiency improvements, service differentiation, or an exit strategy to cope with the reduced market price.

Step-by-step explanation:

A. Should Smith Autos stay in business?

To determine if the business is profitable, let's calculate the total revenue, total costs, and then the profit.

Total Revenue:

Total Revenue = 800 cars/week * $1.5 per car

Total Revenue = $1,200 per week

Total Costs:

Fixed Costs:

Fixed Costs = Return to investors + Insurance

Fixed Costs = $1,000 + $1,000

Fixed Costs = $2,000 per week

Variable Costs:

Variable Costs = Labor + Materials

Variable Costs = $1,000 + $600

Variable Costs = $1,600 per week

Total Costs:

Total Costs = Fixed Costs + Variable Costs

Total Costs = $2,000 + $1,600

Total Costs = $3,600 per week

Profit:

Profit = Total Revenue - Total Costs

Profit = $1,200 - $3,600

Profit = -$2,400 per week

Considering the company's current operational scenario, it's making a loss of $2,400 per week. With this level of loss, it might not be feasible for Smith Autos to stay in business.

B. Graphical Representation of Profit/Loss

In a graphical representation, the total revenue line would be the straight line at $1,200 (since revenue is constant at $1.5 per car wash), and the total cost line would start at $3,600 (fixed + variable costs). The resulting graph would show a downward sloping line indicating a loss.

C. High Pricing within a Gated Community

The car wash company inside the gated community can charge a higher price due to limited competition (monopoly or oligopoly situation) and potentially higher perceived value by residents of the community. The exclusivity of the location allows this business to charge a premium.

D. Market Price Reduction to $1.5 per Car Wash

If the market price decreases to $1.5 per car wash, Smith Autos should consider a few options:

• Reduce Costs: Find ways to cut down costs, negotiate better deals on materials, or optimize labor expenses.
• Increase Efficiency: Try to increase the number of cars washed per week to spread fixed costs over more units.
• Differentiate Services: Offer additional services or improve the quality of service to potentially justify a higher price.
• Consider Exit Strategy: If unable to sustain operations with the reduced price, consider exiting the market or changing the business model.

Understanding the market conditions and being flexible in adjusting costs and services might be crucial for Smith Autos to survive in a highly competitive market with reduced prices.