What is the minimum level of the delivery fee

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Reference no: EM132640141

July would like to start a new business, InterCafe, an online grocery delivery service. July knows that others have a similar idea, and thus anticipates that InterCafe will operate in a perfectly competitive grocery delivery industry.

July anticipates that InterCafe and other grocery delivery services will charge the same prices as local supermarkets for the grocery products and charge a separate delivery fee. The decision July faces is what his costs are for actually delivering the groceries, and what the market price for grocery delivery fee will be.

July estimates InterCafe's costs, not counting the costs of the groceries, as follows. InterCafe will have $250,000 in setup costs. These will cover the construction of the website, the implementation of order processing and inventory management computer systems, and an initial advertising campaign. These are all specific to InterCafe and will have no salvage value if the business closes.

July's rich grandmother has loaned him the $250,000 necessary to start InterCafe. He must repay her over three years, but she is charging him no interest. (You are meant to assume there is no opportunity cost associated with the $250,000.) July is grateful to his grandmother and will only open InterCafe if he expects that the prices will be high enough to cover his costs, including repaying his grandmother.

InterCafe will lease a warehouse for 3 years at a cost of $10,000 per month. July is committed to making the lease payments for 3 years; if the business fails, his rich grandmother, who will not go bankrupt, will be responsible for them. The warehouse will have capacity for 5000 grocery deliveries per month.

InterCafe will also lease 25 delivery trucks for $600 per truck per month. Each truck can make 200 deliveries per month, for a total capacity of 5000 deliveries per month. July can get out of the leases of the trucks with 2-week notice. July will also hire drivers to make the deliveries, at a cost of $6 per delivery. July can fire employees with 2-week notice. Each delivery also requires $1 in gasoline.

The only other employee is July, who will pay himself $2,500 per month. This is equal to the salary his brother Von has offered to pay him at any time if July wishes to join Von's business.

Per delivery costs

Cost per
Category delivery Note
Gasoline $1
Labor $6
Truck $3 $600 per month divided by 200 deliveries per month
Warehouse $2 $10,000 per month divided by 5000 deliveries per month
Computer system $1.11 $200,000 divided by 5000*36 deliveries in 36 months
Initial advertising $0.28 $50,000 divided by 5000*36 deliveries in 36 months
July's salary $0.50 $2500 divided by 5000 deliveries per month

1 What is the minimum level of the delivery fee at which July would decide to start InterCafe? Explain.

2. July decides to open InterCafe. After he has gotten the business going, he discovers that there has been more entry into this industry than he expected. The going market price for the delivery fee, which is the fee July must set, is $9.50 per delivery. July conveys the bad news to his grandmother, a very astute businesswoman. Do you think his grandmother advises him to close his business immediately, plan to close by a month from now, or plan to stay in business? Why?

3 As soon as July gets back to the office from talking to his grandmother, he discovers that a number of his competitors have closed up shop. Over the course of the next few days, he gathers information on the industry, and then calls his grandmother back. He tells her that he now expects the equilibrium delivery charge to be $13. What do you think his grandmother advises him to do now: close his business immediately, plan to close by a month from now, or plan to stay in business? Why?

Reference no: EM132640141

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