If the Rhine Company ignores the possibility that other firms may enter its market, it should set a price of $10,000 for its product, which is a power tool. But if it does so, other firms will begin to enter the market. During the next two years it will earn $4 million per year, but in the following two years it will earn $1 million per year. On the other hand, if it sets a price of $7,000, it will earn $2.5 million in each of the next four years because no entrants will appear.
a. If the interest rate is 10%, should the Rhine Company set a price of $7,000 or $10,000? Why? (Consider only the next four years.)
b. If the interest rate is 8%, should the Rhine Company set a price of $7,000 or $10,000? Why? (Consider only the next four years.)
c. The results in parts (a) and (b) pertain to only the next four years. How can the firm's managers extend the planning horizon?