Practice Questions for 1.7

Practice 1: Decision Tree

The Denby Bakery must replace its oven. A programmable electric oven from Germany will cost £100,000 and could generate a maximum contribution of £500,000. The chance of this happening is only 1 in 10. It is 5 times more likely that the contribution will be £200,000. It is also possible that disappointing demand will place a ceiling of £80,000 on the contribution generated. A gas oven from Yorkshire will cost only £40,000 and is believed to have a 50/50 chance of generating either £150,000 or £80,000 contribution.

4.1 Draw the tree

4.2 Show your calculations, workings and decision

Practice 4: Force-Field Analysis

The Berkeley is a movie theatre owned by Ed Andrews. It shows old movies and recent independently financed films. The movies appeal to niche audiences, which would not be shown at the multi-screen cinema complex called The Max located five kilometres away.

As a sole trader, Ed’s financial position is deteriorating. Only 40 % of films shown at The Berkeley return a small profit. The manager of The Max phoned Ed two months ago and offered to takeover The Berkeley. Ed politely refused.

Cinema attendance has declined and Ed is aware that technology is changing people’s viewing habits. Recent releases of old movies on DVD and the lower price of home cinema systems to show these movies have led evening attendances to fall dramatically. Ed has calculated the cross-elasticity of demand for movie tickets, in relation to the price of these DVDs. He found that movie attendance at The Berkeley and DVD releases were very close substitutes.

Ed has just been offered a chance to be the first cinema in the region to show the second film “Film X”, of a young filmmaker called Judd Peterson. Judd’s previous movie had been a huge success. The potential demand for his “Film X” is so high that it would be shown twice at this premiere but Ed must guarantee a target profit of US$10 000. Ed anticipates selling all tickets at both showings.

Ed has prepared some figures for his break-even analysis if he shows “Film X”:

• capacity of The Berkeley = 1200 per showing

• price of movie ticket = US$12

• fixed costs = US$12 000 (this includes target profit of US$10 000) to be split equally over the 2 showings

• variable costs per ticket sold = US$6.

Ed has a dilemma: if “Film X” is successful, The Berkeley will receive a substantial revenue boost as well as free publicity. This could also help Ed bring more diverse films to The Berkeley, especially little known international films, which would fulfil a long-held ambition of his. However, if he shows “Film X”, Ed risks changing the perception of customers that The Berkeley provides films for a niche market to a perception that it provides films for a mass-market2. He is concerned that customers would expect similar movies in the future.

1. Analyse the relative importance of driving and restraining forces on The Berkeley if Ed decides to show “Film X”.

2. Create a force field analysis diagram to show the driving and restraining forces

Hints and Tips for Force-Field Analysis:

Key driving forces:

• Ed’s determination to achieve his ambition for his niche audience

• the ability to spread his passion for “world cinema” or “festival” movies

• a fear of consenting to the takeover bid by The Max as Ed, the sole trader, is facing difficulties

• the fragile state of the finances of The Berkeley with the majority of films shown not breaking even

• use of technology at home affecting the nature of demand for The Berkeley’s films

• Judd’s previous success and anticipated demand for the premiere of “Film X”.

Key restraining forces:

• fear of irrevocably changing the perception of The Berkeley away from Ed’s ambition

• fear of imitation or me-too aspect with respect to The Max, which might damage The Berkeley as they do not have the economies of scale or financial muscle to compete with The Max

• fear of alienating existing customers.