. Between 0 and 1 are a 1000 customers, evenly distributed. Each of these cus- tomers wants exactly one unit of SOMA. Travel costs are a $1 a mile. Hence, the cost to a customer at distance d from LEFT of going to LEFT to purchase a unit of SOMA is d. The cost of going to RIGHT is 1 − d. Given the prices charged by LEFT and RIGHT, customers base their purchase decisions on the relative delivered cost of the product. The delivered cost is the travel cost plus price of the item. For example, the delivered cost of the customer
at distance d from LEFT, is d + pL, where pL is the price per unit of SOMA being charged by LEFT. If pR were the selling price of SOMA at RIGHT, this customer would buy from LEFTifandonlyifd+pL <1−d+pR.
If the inequality were reversed, the customer would buy from RIGHT. Ignore the case of a tie.
1. If variable manufacturing costs are zero, what price will each firm charge in equilibrium?
2. For this part only, suppose that LEFT’s marginal costs increase from zero. What effect does that have on the equilibrium price?
3. For this part only suppose that both LEFT and RIGHT have a marginal cost of produc- tion of $2. If the marginal costs of production for both firms drops, what effect will this have on the equilibrium price? Will it decrease, increase or stay unchanged?
4. Suppose LEFT could choose to set its price first (before RIGHT announces a price and that LEFT’s choice is irrevocable) or simultaneously with RIGHT. Which is more profitable for LEFT?
5. Suppose LEFT could choose to set its price first (irrevocably and before RIGHT), second (after RIGHT sets a price that is irrevocable) or simultaneously. Which is the best option for LEFT?
1. Paul and Jon are partners in a small successful restaurant. They want to expand but need a second location. They think their business has a FMV of $2,000,000 (and has a basis of $500,000 to Paul and a basis of $250,000 to Jon).
2. Jason is a real estate broker and investor. He normally buys real estate and sells it quickly. He is fully licensed as a real estate broker in Texas. Jason has a vacant lot that he paid $1,800,000 several years ago. The FMV is currently $1,000,000.
3. Jason has a big gain from his business this year and would love to offset it somehow but does not know how to do so. Paul and Jon do not want the transaction to cause them any gain this year
4. Paul and Jon approach Jason about the following business proposition: the restaurant and the land are contributed to a new corporation. Each gets 1/3 of the stock.
5. Jason is not sure he likes that idea and instead offers the following:
The corporation will distribute out to Jason a part of the parking lot (of the old location). The FMV is $200,000 and the basis to the corp is $75,000. Jason will contribute the new land for a 5 year note plus 3% annual interest, 15% of the stock and $300,000 in cash.
After the first year the corporation will distribute out to Jason another part of the old parking lot (FMV 250,000, basis to the corp of $100,000)
6. If #5 does not work- then Jason would take $750,000 in preferred stock (or options for common stock) and $250,000 in value of the parking lot land (see #5) but would want a fixed 10% dividend, conversation to common rights and a liquidation preference (if preferred stock).
7. Keep in mind Jason wants to own part of the restaurant- he thinks it will be successful…..
What is the income tax consequences idea #4?
What is the income tax consequences idea #5?
What is the income tax consequences idea #6?
Is there a better economic structure that will give the three people the result they desire? If so what it is and defend the idea.