Cost-Plus Pricing
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1. Wendel Stove company is developing a "professional" model stove aimed at the home market. The company estimates that variable costs will be $2000 per unit and fixed costs will be $10,000,000 per year.
Required
a. Suppose the company wants to sets its price equal to full cost plus 30 percent. To determine the cost, the company must estimate the number of units it will produce and sell in a year. Suppose the company estimates that it can sell 5000 units. What price will the company set?
b. What is "odd" about setting the price based upon an estimate of how many units will be sold?
c. Suppose the company sets a price as in the part a, but the number of units demanded at the price turns out to be 4000. Revise the price in light of demand for 4000 units.
d. What will happen to the number of units that will sold if the price is raised to the one you calculated in part c?
e. Explain why setting price by marking up cost is inherently circular for a manufacturing firm.
2. Emerson Ventures is considering producing a new line of hang gliders. The company estimates that variable costs will be $325 per unit and fixed costs will be $330,000 per year.
Required
a. Emerson has a pricing policy that dictates that a product's price must be equal to full cost plus 60 percent. To calculate full cost, Emerson must estimate the number of units it will produce and sell in a year. Emerson estimates at the beginning of year that they will sell 1500 gliders and sets their price according to that sales and production volume. What is the price?
b. Right after the beginning of the year, the economy takes a dive and Emerson finds that the demand for their gliders has fallen drastically; Emerson revises its sales and production estimate to just 1000 gliders for the year. According to company policy, what price must they now set?
c. What is likely to happen to the number of gliders sold if Emerson follows company policy and raises the glider price to that calculated in part b?
d. Why is setting price by marking up cost is inherently circular for a manufacturing firm.
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Solution Summary
There are two problems related to Cost-Plus pricing. Solutions to these problems explain the methodology to determine the price based upon this approach.
Solution Preview
Please refer attached file better clarity of formulas.
Solution:
Problem 1
a.
Fixed Costs=$10,000,000
Fixed Costs=$10,000,000
Variable Costs=2000*5000=$10,000,000
Total Costs =$10,000,000+$10,000,000=$20,000,000
Total Cost per unit=20,000,000/5000=$4,000
Price=4000*(1+30%)=$5,200
b.
Price is based upon sell estimation which is highly unpredictable. It also depends upon the prices set by the company and strategy adopted by the ...
Education
- BEng (Hons) , Birla Institute of Technology and Science, India
- MSc (Hons) , Birla Institute of Technology and Science, India
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