b L,FRE
Is diversification from small tractors to big tractors a good idea for
Deere's stockholders?
Deere's stockholders can diversiS, more cheaply themselves now.
For example, they can buy CAT shares.
The two markets (small and big tractors) are cyclical. However, the big tractor market is more cyclical.
Hence Deere should not use its current cost of capital for making decisions. This is important since, if alarge tractor is sold for
S100, an additional revenue of $65 is generated in the first three

Years'

r\

^
^'?t
aLl""'' tur-'a '
-''*2
In fact, since the appropriate discount raG is higher than before, future profits are less valuable in the large tractor market than in the small tractor market. An additional factor is that Deere's parts are not proprietary---- hence future revenue (profits) from parts are not as high for Deere as for CAT.
Conclusion: Deere should price closer to the 'myopic' price in the large tractor market than in the small tractor market.
Cash flows: The cash flows in the small and large tractor markets are not perfectly correlated, even thought both markets are cyclical. Hence diversification from small to large tractors will smooth out cash flows----- reduces the risk to Deere's bondholders
(lowers the interest rate demanded by bondholders). This could add value to Deere.

4\^^X L,*)
S-r,

4

t or"/o

hrt

th"Al

Fa"rfr
\

(

r.

vrwF^e.,

I

-{W

I

t

Explain the role of spare parts on pricing:

tr

Y

of*'

1'nod-ol'

(

\\c{.r.tl* t 'wti

I'IFY I F'r'o*

1knffiA \,t P nn-'lpt.,) ' \ tuM{'
P\"!1u"Lant?

.1'**

Ff""k/

Pu

Vf0"^*

-e {*ttdn fp, + WcbV

Definition of product quality:
This is a verticallv differenti

nellts are re to HP and to cost savings.) He-riEeT6[ffi paribus, quality is based on Hp.

Implication: As

price based on\ u, b X equivalent horsepower, BUT, note that this would be true in a 'GL
J
competitive market where all consumers are fullv informed. a benchmark, Deere should set

'I tM*1 NIV t!fi*