Solutions_to_Homework__2

Solutions_to_Homework__2 - Management Science & Engineering...

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Spring, 2008 Homework #2 Due: Beginning of class, April 22 1. Forward contracts and asset-liability matching a) Company A must first invest in capacity and then purchase long lead time materials in order to produce its products. If the company sells a commodity product, explain why the company must use forward contracts with its customers to ensure its profitability. The company incurs substantial costs well in advance of its sales to customers, through its investments in capacity and long lead time materials. In order to ensure it recovers its cost with an appropriate profit margin, it must protect itself against uncertainty in both the quantity and pricing of its future product sales, which can be done with forward contracts. b) To manufacture its product, company B purchases commodity materials at fluctuating market prices and pays a contract manufacturer a negotiated fee per unit to assemble its products from them. If the company does not enter into forward contracts with its customers, describe how it must price its products in order to maintain a constant gross margin. Because the company’s cost structure varies as 1) the cost of its commodity materials fluctuate over time, and 2) the per unit fee it pays its contract manufacturer is periodically renegotiated, to maintain a consistent gross margin it must change its product pricing in parallel with such changes over time. There are some businesses, like
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This note was uploaded on 06/16/2010 for the course MS&E 369 taught by Professor Blakejohnson during the Spring '08 term at Stanford.

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Solutions_to_Homework__2 - Management Science & Engineering...

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