1) The document discusses pricing decisions and defines key terms like price, pricing policy, and profit maximization.
2) It outlines major factors that influence pricing decisions like customers, competitors, and costs. It also describes different bases for applying a mark-up, like prime costs, conversion costs, and returns on capital employed.
3) Examples are provided to illustrate how to calculate the optimal selling price to maximize profits based on variable costs, demand at different price points, and different mark-up percentages applied to costs. The minimum price based on differential costs is also calculated for excess capacity.
1) The document discusses pricing decisions and defines key terms like price, pricing policy, and profit maximization.
2) It outlines major factors that influence pricing decisions like customers, competitors, and costs. It also describes different bases for applying a mark-up, like prime costs, conversion costs, and returns on capital employed.
3) Examples are provided to illustrate how to calculate the optimal selling price to maximize profits based on variable costs, demand at different price points, and different mark-up percentages applied to costs. The minimum price based on differential costs is also calculated for excess capacity.
1) The document discusses pricing decisions and defines key terms like price, pricing policy, and profit maximization.
2) It outlines major factors that influence pricing decisions like customers, competitors, and costs. It also describes different bases for applying a mark-up, like prime costs, conversion costs, and returns on capital employed.
3) Examples are provided to illustrate how to calculate the optimal selling price to maximize profits based on variable costs, demand at different price points, and different mark-up percentages applied to costs. The minimum price based on differential costs is also calculated for excess capacity.
1) The document discusses pricing decisions and defines key terms like price, pricing policy, and profit maximization.
2) It outlines major factors that influence pricing decisions like customers, competitors, and costs. It also describes different bases for applying a mark-up, like prime costs, conversion costs, and returns on capital employed.
3) Examples are provided to illustrate how to calculate the optimal selling price to maximize profits based on variable costs, demand at different price points, and different mark-up percentages applied to costs. The minimum price based on differential costs is also calculated for excess capacity.
PRICE The money consideration asked for or offered in exchange for a specified unit of a good or service.
PRICE SYSTEM Any comprehensive scheme of determining selling price to the trade, particularly those to which leaders of the industry subscribe. PRICING DECISION
PRICING POLICY The body of principles followed over a period of time by the management of a business enterprise in fixing the selling price of its product or service.
PROFIT MAXIMIZATION In pricing is to obtain a price that contributes the largest amount of profit. The price that yields the largest profit at a certain volume is the price to be set- up and charged to customers. Major factors that influence PRICING Pricing Decisions DECISION
1. Customers – Customers always have an
alternative source of supply, can substitute one material for another, and may make a part rather than buy it if the vendor’s prices are too high 2. Competitors – They will usually react and monitor to price changes made by their rivals. 3. Costs – Cost plus added reasonable mark- up that will generate an adequate return on investment is normally used by many businesses in setting their prices Bases of applying Mark-On (mark- PRICING up) in establishing Selling Price DECISION
1. Prime Costs – Based on cost of direct materials
and direct labor. 2. Conversion Costs – Based on the cost of direct labor and manufacturing overhead. 3. Full Production Costs – Based on the cost of direct materials, direct labor, and manufacturing overhead. 4. Variable (Direct) Production Costs – Based on the cost of direct materials, direct labor, and variable manufacturing overhead. Bases of applying Mark-On (mark- PRICING up) in establishing Selling Price DECISION
5. Variable Costs – Based on the cost of direct
materials, direct labor, variable manufacturing overhead, and variable selling and administrative expenses. 6. Full (Total) Costs – Based on the cost of materials, direct labor, manufacturing overhead, and selling and administrative expenses. 7. Differential Costs – Based on added costs that are identified to additional units produced and sold, normally variable costs. Pricing based on a return on PRICING Capital (Investment) Employed DECISION The formulas used in this pricing technique provide measure of the degree of efficiency with which total assets are utilized to generate earnings for the business.
A. Total Assets (Capital Employed)
Unit Selling Price = Total Cost + (Rate of Return x Capital Employed) Sales Volume in Units
B. Plant Assets (Fixed Capital)
Unit Selling Price = Total Cost + (Rate of Return x Fixed Capital) Sales Volume in Units 1 – (Rate of Return x Variable Capital Ratio) PRICING DECISION
EXAMPLE PROBLEMS Problem 1 PRICING DECISION The Maxim Company will be marketing a new product and is trying to set- up the selling price that would give the largest amount of profit. Based on market studies made, the following data were made available. Sales Price Sales Sales Price Sales Per Unit Demand in Per Unit Demand in Units Units ₱10 10,000 ₱7 40,000 9 20,000 6 50,000 8 30,000 5 60,000
Maxim can produce the above sales demand with its idle capacity. The variable cost to produce and sell each unit is ₱4. The company will incur fixed costs of ₱50,000 which will remain unchanged based on the above demand. REQUIRED: Prepare a schedule that will show which sales price per unit will contribute the largest amount to profit. Solution - Problem 1
Selling Price Sales-Units Total Sales Variable Cost Cont. Margin
The above schedule shows that the selling price set between ₱7 and ₱8 will give Maxim the largest contribution to fixed cost and to profit. Any price set above ₱8 and below ₱7 will lower contribution margin. Problem 2 (Mark-On on PRICING Different bases) DECISION The Pride Company started operations on Jan 1, 2008 and expected to produce 200,000 units in its first year of operations. The cost data per unit based on expected production are shown below. Direct Materials ₱48.00 Fixed overhead ₱3.00 Direct labor 12.00 Fixed selling and adm. 2.00 Variable overhead 6.00 Variable selling and adm. 2.50 Management is trying to decide on what selling price would they project the 2004 sales. You are asked to compute the selling price based on each of the following independent cases below: 1. 25% mark-on based on prime cost 2. 70% mark-on based on conversion cost 3. 20% mark-on based on full production costs 4. 22% mark-on based on variable production cost 5. 20% mark-on based on full cost 6. 24% mark-on based on variable cost
7. Assuming Pride has excess capacity after 200,000 units and an offer to buy 20,000 units by a foreign buyer is received, determine the minimum price (DIFFERENTIAL COST) on Solution – Problem 2
1. 25% mark-on based on Prime Cost
Direct Materials ₱48.00 Direct labor 12.00 Prime Cost ₱60.00 Variable Overhead 6.00 Fixed overhead 3.00 Variable selling and adm. 2.50 Fixed selling and adm. 2.00 Full Costs per Unit ₱73.50 Mark-on (₱60.00 x 25%) 15.00 Selling Price Per Unit ₱88.50 Solution – Problem 2
Mark-on (₱21.00x70%) 14.70 Selling Price Per Unit ₱88.20 Solution – Problem 2
3. 20% mark-on based on full production costs
Direct materials ₱48.00 Direct labor 12.00 Variable overhead 6.00 Fixed overhead 3.00 Full Production Costs ₱69.00
Full Cost per unit ₱73.50
Mark-on (₱69.00x20%) 13.80 Selling Price Per Unit ₱87.30 Solution – Problem 2
4. 22% mark-on based on variable production cost
Direct materials ₱48.00 Direct labor 12.00 Variable overhead 6.00 Variable Product Costs ₱66.00
Full Cost per unit ₱73.50
Mark-on (₱66.00x22%) 14.52 Selling Price Per Unit ₱88.02 Solution – Problem 2
5. 20% mark-on based on full cost
Full Cost per unit ₱73.50
Mark-on (₱73.50x20%) 14. 70
Selling Price Per Unit ₱88.20
Solution – Problem 2
6. 24% mark-on based on variable cost
Direct materials ₱48.00 Direct labor 12.00 Variable overhead 6.00 Variable Selling and adm. 2.50 Total Variable Costs 68.50
Full Cost per unit ₱73.50
Mark-on (₱68.50x24%) 16.44 Selling Price Per Unit ₱89.94 Solution – Problem 2
7. Assuming Pride has excess capacity after 200,000 units and an offer to buy 20,000 units by a foreign buyer is received, determine the minimum price (DIFFERENTIAL COST) on this offer. No selling and administrative costs will be incurred except ₱2 per unit for shipping
NOTE: The differential approach to pricing presumes that the price must at least equal the differential cost of producing and selling the product. The differential approach particularly helps in making special-order decisions. Problem 3 PRICING DECISION Sport Company expects to produce 150,000 units of Product X during 2004. The sales demand is expected to be 150,000 units. The company provided the following data. Standard Unit Cost:
Direct Material ₱8.20 Budgeted annual fixed and ₱200,000
administrative expenses Direct labor 4.50 800,000 Total capital employed Variable overhead 2.30
Fixed Overhead 2.00 Expected rate of return on 30%
investment Standard Product Cost ₱17.00
Variable Selling & adm. 2.50
REQUIRED: a. Compute the expected selling price. b. Compute the expected selling price if customers are entitled to 3% sales discount Solution – Problem 3
a. Unit Selling Price = ₱2,930,000 + (30% x ₱800,000)
140,000 units = ₱22.64
*[₱200,000+(140,000 x ₱19.50)] = ₱2,930,000
b. Gross Selling Price Per Unit = [₱22.64/(100%-3%)]
= ₱23.34 Problem 4 PRICING DECISION The Retain Company started operations in 2008 with an expected production of 120,000 units and sales volume of 110,000 units. It has a normal operating capacity of 100,000 units. The following data were made available. Variable mfg. cost per unit ₱ 25.40 Fixed mfg. cost per unit based on normal capacity 5.20 Variable selling and administrative cost per unit 6.60 Annual fixed selling and administrative expenses 240,000 Plant asset (fixed capital) used in operations 900,000 Expected ratio of current assets to projected sales 30%
The company is projecting a selling price that would give them a 25% return on investment. REQUIRED: Compute the selling price per unit that will meet the expected results based on the above data. Show proof of answer. Solution – Problem 4
Computation of Total Cost:
Variable costs (₱25.40+₱6.60) x 110,000 units ₱3,520,000 Fixed manufacturing costs (₱5.20 x 100,000) 520,000 Fixed selling and administrative 240,000 Total Costs 4,280,000
110,000 units 110,000 92.5% 1 – (25% x 30%) 92.5% Solution – Problem 4 Proof of Answer: Sales(110,000 x ₱44.27) ₱4,869,700 Variable Costs 3,520,000 Contribution Margin ₱1,349,700 Fixed Costs: Manufacturing ₱520,000 Selling and administrative 240,000 760,000 Net Income ₱589,700 Plant Assets ₱900,000 Variable Capital (₱4,869,700 x 30%) 1,460,910 Total Capital Employed ₱2,360,910
Return on Capital Employed = ₱589,700 = 25%
₱2,360,910 Problem 5 PRICING DECISION The Exxon Company’s normal sales volume is 500,000 units. The unit cost to make and sell Exxon’s product are as follows: Direct materials ₱50.00 Fixed Factory overhead ₱15.00 Direct labor 25.00 Variable selling and adm. 8.00 Variable factory overhead 10.00 Fixed selling and adm. 7.00
Beginning 2008, replacement cost of direct material is ₱55 per
unit, labor contract provides an increase of 20% and variable selling cost to increase by 10%. Sales discount average 3% on gross sales.
REQUIRED: Compute the unit-selling price to be set-up if
management desires a profit of 25% based on full costs. Solution – Problem 5
Direct materials ₱55.00
Direct labor (₱25 x 120%) 30.00 Variable factory overhead 10.00 Fixed factory overhead 15.00 Variable selling and administrative (₱8.00 x 110%) 8.80 Fixed selling and administrative 7.00 Full Cost per unit ₱125.80 Add: Mark-up (₱125.50 x 25%) 31.45 Net Selling Price ₱157.25 Divide by Percent of Net Selling Price 97% Gross Selling Price ₱162.11
