Sensitivity, Prediction Errors, and Inflation Refer to Problem 3-10. As president of Look Rite, you are concerned that inflation may squeeze your profits. Specifically, you feel committed to the five-dollar selling price and fear that diluting the quality of the packs in the face of rising costs will be an unwise marketing move. You expect cost prices of the packs to rise by 10 percent during the forthcoming year. Therefore, you are tempted to avoid the price rise by placing a noncancellable order with a large supplier that would provide 50,000 packs of a specified quality for each store at $4 per pack. (To simplify this analysis, assume that all stores will face identical demands.)

These packs could be acquired and paid for as delivered throughout the year. However, all packs must be delivered to the stores by the end of the year.

As a shrewd merchandiser, you can foresee some risks in the sense that you deal exclusively in high-fashion goods that are subject to rapid obsolescence.

If sales were less than 50,000, you feel that markdowns of the unsold merchandise would be necessary to move the goods. You predict that the average selling price of the leftover packs would be $3. The regular sales commission of 5 percent of sales would be paid.

Suppose that the actual demand for the year is 48,000 packs and that you contracted for 50,000 packs. What is the net profit for the store?
If you had had perfect knowledge, you would have contracted for 48,000 rather than 50,000 packs. What would the net profit have been if you had ordered 48,000 packs? Having ordered 50,000 instead, what was the cost of your prediction error?
Given an actual volume of 48,000 units, by how much would the average purchase cost of the pack have had to rise before you would have been indifferent between having the contract for 50,000 packs and not having the contract? lop1