Understanding the Passage
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.HOB (Hotco Oil burners) are so efficient that Hotco (probably the company that produces HOB) will sell one of these burners to CAP (Clifton Asphalt plant) for only the cost savings between the total expenditure of CAP on oil over the last two years and the total expenditure of CAP on oil using HOB over the next two years.
Cost Savings = the total expenditure of CAP on oil over the last two years – the total expenditure of CAP on oil using HOB over the next two years.
For example, if CAP spent Rs 100 on oil in the last two years and will spend Rs 75 on oil over the next two years, the cost savings will be Rs 100 – Rs 75 = Rs 25.
On installation, the plant will make an estimated payment, which will be adjusted after two years to equal the actual cost savings.
When this burner is installed in CAP, CAP will make an estimated payment to Hotco; this payment will be adjusted after two years to equal the actual cost savings. (If actual cost savings happen to be more than the estimated payment, CAP will pay the difference to Hotco. If actual cost savings turn out to be less than the estimated payment, Hotco will need to pay to CAP.)
Understanding the Question Stem
Which of the following, if it occurred, would constitute a disadvantage for Hotco of the plan described above?
We’re looking for an option that gives a disadvantage for Hotco of the plan described above.
Can you think of any situations which could be disadvantageous to Hotco, given the above plan?
Hotco will be at a disadvantage if the cost savings go down.
Cost Savings = the total expenditure of CAP on oil over the last two years – the total expenditure of CAP on oil using HOB over the next two years.
We can see that Hotco will be at a disadvantage if the total expenditure of CAP on oil using HOB over the next two years goes up.
How can the total expenditure on oil go up?
I can think of two scenarios:
1. The price of oil goes up.
2. CAP will produce more over the next two years than it produced during the last two years. More production will require more fuel.
Some of you may be wondering that even if the price of oil goes up, the cost savings MUST still be there by using a more efficient burner. If you’re thinking so, you need to ask yourself, “cost savings in comparison to what?”
The answer would be: cost savings in comparison to using a non-efficient burner.
You’re right. There would be cost savings by using an efficient burner compared to a non-efficient burner.
However, the way the cost savings are calculated in the passage is different. In the passage, the cost savings are NOT calculated using an efficient burner over the next two years vis-a-vis using the existing burner over the next two years.
The cost savings are calculated using the expenditure on oil over the next two years vis-a-vis the expenditure on oil over the past two years.
Given this way of calculation, the changes in the price of oil have an impact on cost savings.
Similarly, some of you would also be wondering about my second point and thinking why Hotco should be at a disadvantage if CAP produces more over the next two years. The reasoning is the same. Given how cost savings are calculated, if CAP consumes more oil, cost savings will go down, and thus the payment to Hotco will go down.
The Evaluation
A) Another manufacturer’s introduction to the market of a similarly efficient burner
Incorrect. Whether there are similarly or even more efficient burners in the market has NO IMPACT on the payment to Hotco.
Increased competition could be a disadvantage for Hotco, in general. However, increased competition would not constitute a disadvantage for Hotco w.r.t. the given payment plan.
B) The Clifton Asphalt plant’s need for more than one new burner
Incorrect.
CAP’s need for more than one burner could be borne out of the size of the existing burner vis-a-vis the size of Hotco burners. Or it could be that CAP already has more than one burners, and it’ll need a new burner for every old burner that it has.
However, how many Hotco burners are needed does not impact the argument since the same plan can be followed for the same burner.
Can we say that this option indicates that CAP will increase its production over the next two years?
I don’t think so. Why? Because the option doesn’t talk about the future. It’s not saying that CAP will need more burners in the next two years. It says that right now, it has a need for more than one burner. That doesn’t impact Hotco’s plan.
In addition, it’ll be helpful to note that the given plan is for one burner, and the question is w.r.t. the plan. Thus, a need for more burners will not impact the argument.
C) Very poor efficiency in the Clifton Asphalt plant’s old burner
Incorrect. If the old burner were very inefficient (as the option says), Hotco will be at an advantage. This option goes in the OPPOSITE direction.
D) A decrease in the demand for asphalt
Incorrect. A decrease in the demand for asphalt indicates a decrease in the production of CAP. If CAP produces less, it will use less oil over the next 2 years. As a result, cost savings will increase. As a result, Hotco will be at an advantage. Thus, this option too goes in the OPPOSITE direction.
E) A steady increase in the price of oil beginning soon after the new burner is installed
Correct. This option relates to the first point of disadvantage we thought of. If the price of oil goes up, CAP will pay more for oil over the next two years than it would need to at the old price of oil. As a result, cost savings will be less than expected. As a result, Hotco will be at a disadvantage.