A movie studio sells the latest movie on DVD to Blockbuster at $11 per DVD. The marginal production cost for the movie studio is $2 per DVD. Blockbuster prices each DVD at $23 to its customers. DVD s are kept on the regular rack for a one-month period, after which they are discounted down to $4. Blockbuster places a single order for DVDs. Their current forecast is that sales will be normally distributed, with a mean of 100,000 and a standard deviation of 40,000.

a. How many DVDs should Blockbuster order?

b. What is its expected profit?

c. What is the profit that the studio makes given Blockbuster’s actions?

[Refund Contract] A plan under discussion is for the studio to refund Blockbuster $3 per DVD that does not sell during the one-month period. As before, Blockbuster will discount them to $4 and sell any that remain.

d. Under this plan, how many DVDs should Blockbuster order?

e. What is the expected profit for Blockbuster?

f. What is the expected profit for the studio?

g. Does it make sense for the studio to offer this plan? Explain.

[Revenue-Sharing Contract] A second plan under discussion is a revenue-sharing contract. The studio will set the wholesale price at $6.75 in return for 20% of the sales revenue. As before, any unsold DVDs are discounted by Blockbuster to $4, and all sell at this price.

h. Under this plan, how many DVDs should Blockbuster order?

i. What is the expected profit for Blockbuster?

j. What is the expected profit for the studio?

k. Which contract should the studio choose: Refund, or Revenue Sharing? Explain.