Question

"a monopolist earns $50 million annually and will maintain that level of profit indefinitely, provided no other firm enters the market. if another firm successfully enters the market, the incumbent's profits remain at $50 million the first period, but fall to $25 million annually thereafter. the opportunity cost of funds is 10 percent, and profits in each period are realized at the beginning of each period. what is the present value of the firm's current and future earnings if entry occurs?"

Answer 1

A monopolist earns a profit of $50 million annually and will have the same indefinitely.

$Present value of Perpetuity = D/r$

where D = Annuity ($50 million)

R = Rate of interest (10%)

$Current Value = 50,000,000 ÷ 0.1\\Current Value = 500,000,000$

Therefore the current value is $500,000,000

Now, if another player enters the market.

$Present Value = 50,000,000/(1+0.1)^1 + 25,000,000/0.1$

$Present Value = 45,454,545.45 + 250,000,000 Present Value = 295,454,545.45$

Therefore, the present value of future period is $295,454,545.45