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OG 12 Qs # 96 : Hotco oil burners, designed to be used in as

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OG 12 Qs # 96 : Hotco oil burners, designed to be used in as

by RBBmba@2014 » Fri Oct 17, 2014 6:06 am
Hotco oil burners, designed to be used in asphalt plants, are so efficient that Hotco will sell one to the Clifton Asphalt plant for no payment other than the cost savings between the total amount the asphalt plant actually paid for oil using its former burner during the last two years and the total amount it will pay for oil using the Hotco burner during the next two years. On installation, the plant will make an estimated payment, which will be adjusted after two years to equal the actual cost savings.

Which of the following, if it occurred, would constitute a disadvantage for Hotco of the plan described above?

A) Another manufacturer's introduction to the market of a similarly efficient burner
B) The Clifton Asphalt plant's need for more than one new burner
C) Very poor efficiency in the Clifton Asphalt plant's old burner
D) A decrease in the demand for asphalt
E) A steady increase in the price of oil beginning soon after the new burner is installed

Hi,
I'm not able to understand this...why and how option E is correct ? IMO,even if there is any significant increase in oil prices in next two years after the installation,leading to offset the cost savings due to Hotco burner efficiency, Hotco will get the payment on installation. Right ?

Just curious why OA is E, could this be a probable reason for it(re E) being a weakener - per the argument, this payment would be adjusted with actual cost savings. Now,as there is steady/significant increase in oil prices in next two years after the installation so actual cost savings would be naturally much less than what was anticipated. Hence,Hotco might need to return a part of the payment it received from the plant at the time of installation. Is this the line of reasoning depicted here for E to be the OA ? If so, then please clarify is this rational/practical - can any company return any any cost for its service/product in such a way ?

If not, then please share your analysis.

Also,please let me know what's wrong with option A ? I can't agree with the explanation given in OG for option A as I don't find where it's explicit in the argument that the installation is already done that presence of other competitors won't be an issue at all?

@ Experts - look forward to your detail analysis.Much thanks!
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by Eli@Prep4GMAT » Fri Oct 17, 2014 7:39 am
Hotco: "So you spend $5000 on 1000 units of oil in the last two years. Instead, why don't you install our burners; you'll need only 800 units of oil. Since that will cost you only $4000, you can give us the savings as the only payment we need--and if you end up spending more, we'll refund the difference!"

Two years later:

Asphalt company: "The past two years, we spent $5000 on oil. There were no savings. We'd like out money back!"

Hotco: "What happened? Did our machines break."

Asphalt company: "No, we only needed 750 units of oil--they worked great. But the price of oil went up so much that we didn't save a penny, and you promised us cash savings!"


Hotco's plan would work fine if oil prices were stable; the asphalt company would have saved a large amount of money, and Hotco would have earned substantial savings. However, a price spike means that even more efficient burners are unlikely to generate lower total costs than in previous years, when prices were lower. Thus, Hotco's plan is questionable.

Hope this helps!
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by GMATGuruNY » Sat Oct 18, 2014 3:11 am
RBBmba@2014 wrote:Hotco oil burners, designed to be used in asphalt plants, are so efficient that Hotco will sell one to the Clifton Asphalt plant for no payment other than the cost savings between the total amount the asphalt plant actually paid for oil using its former burner during the last two years and the total amount it will pay for oil using the Hotco burner during the next two years. On installation, the plant will make an estimated payment, which will be adjusted after two years to equal the actual cost savings.

Which of the following, if it occurred, would constitute a disadvantage for Hotco of the plan described above?

A) Another manufacturer's introduction to the market of a similarly efficient burner
B) The Clifton Asphalt plant's need for more than one new burner
C) Very poor efficiency in the Clifton Asphalt plant's old burner
D) A decrease in the demand for asphalt
E) A steady increase in the price of oil beginning soon after the new burner is installed
PLAN: As compensation for the new, more efficient burner, the asphalt plant will pay Hotco an amount equal to the plant's cost savings on oil.
IMPLIED CONCLUSION: Hotco will make a profit.

The correct answer choice will weaken the conclusion that Hotco will make a profit.

Answer choice E: A steady increase in the price of oil beginning soon after the new burner is installed.
Given the price increase, the asphalt plant might save no money on oil, with the result that no money will be owed to Hotco -- WEAKENING the conclusion that Hotco will make a profit.

The correct answer is E.
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by RBBmba@2014 » Tue Oct 21, 2014 6:20 am
GMATGuruNY wrote:PLAN: As compensation for the new, more efficient burner, the asphalt plant will pay Hotco an amount equal to the plant's cost savings on oil.
IMPLIED CONCLUSION: Hotco will make a profit.

The correct answer choice will weaken the conclusion that Hotco will make a profit.

Answer choice E: A steady increase in the price of oil beginning soon after the new burner is installed.
Given the price increase, the asphalt plant might save no money on oil, with the result that no money will be owed to Hotco -- WEAKENING the conclusion that Hotco will make a profit.

The correct answer is E.
Hi Mitch,
Thanks for your reply but I couldn't understand your reasoning completely!

Could you please help me identify the gap in the logic in my post above for option E ? Per the argument, an estimated payment is already done on installation. So how the 'no cost savings' would be adjusted after two years ?

How we can say that as "...the asphalt plant might save no money on oil, with the result that no money will be owed to Hotco " ? Because,this is a probable scenario after two years whereas payment is already done on installation.

Just curious - are you anyhow tried to convey that only the production cost/cost price (which is equivalent to the estimated payment paid to Hotco) of the burner is paid on installation by plant to Hotco ? So, if there isn't any significant cost savings after two years due to increase in oil price then no further payment will be paid to Hotco by plant, hence Hotco will not make any planned/anticipated profits. Is this what you tried to convey ?

Look forward to hear from you Sir!
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by RBBmba@2014 » Mon Oct 27, 2014 9:14 am
HI Mitch - could you please share your thoughts on my immediate above reply ?

Look forward to your clarification Sir!

Thank you.
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by GMATGuruNY » Tue Oct 28, 2014 5:44 am
RBBmba@2014 wrote: Hi Mitch,
Thanks for your reply but I couldn't understand your reasoning completely!
On installation, the plant will make an estimated payment...
Implication:
If the plant expects to save $1000 in oil, the plant pays $1000 to Hotco.

...which will be adjusted after two years to equal the actual cost savings.
Implication:
If the plant actually saves only $10 in oil, Hotco must return $990 to the plant, with the result that Hotco earns only what the plant has actually saved: $10.

The OA explains why Hotco is unwise to adopt this pricing plan:
If there is a steady increase in the price of oil, then Hotco's earnings -- which will be adjusted after two years to equal only what the plant has actually saved in oil -- could be very, very small.
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by RBBmba@2014 » Tue Oct 28, 2014 6:46 am
I got you Mitch. Just one quick clarification -
GMATGuruNY wrote: If the plant actually saves only $10 in oil, Hotco must return $990 to the plant, with the result that Hotco earns only what the plant has actually saved: $10.
Could this be any sort of real-life business scenario ? I mean,(although this reasoning stands good in this question but) is it realistic ?

Look forward to hear from you.Thanks!
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by kutlee » Wed Apr 01, 2015 6:03 am
I guess the wording is not good. It asks for option that is A DISADVNTAGE instead of MOST DISADVANTAGE.
Options D and E will both have disadvantage. Unless we know which is relatively better option (D or E) we can't say for sure. Since the saings is based on total usage of the equipment, low demand can lead to low utilization and hence less savings.
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