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MM PrE8– MM4
 CHAPTER 3: COST-BASED PRICING

Cost-based pricing is a pricing strategy where a

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business sets the price of its products or services
based on the costs incurred in producing them, plus a
markup for profit. This approach ensures that all costs
are covered while allowing for a predictable profit
margin.
3.1 Cost-plus Pricing Methods
Cost-plus pricing is a straightforward pricing strategy where a
business determines the selling price of a product by adding a specific
markup to its total costs. Here are the main methods used within

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cost-plus pricing:
1. Simple cost-plus pricing is a straightforward method where a
business determines the selling price of a product by adding a
fixed markup to the total production costs. Commonly used in
manufacturing and retail where costs can be easily tracked.
Markup is a predetermined amount or percentage added to the
total cost to achieve a desired profit. This markup can be based on
business objectives, industry standards, or competitive analysis.
Formula: Selling Price = Total Cost + Markup
2. Cost-Plus Fixed Fee Pricing is a pricing strategy commonly
used in industries where the costs of production can
fluctuate significantly, such as construction, government
contracting, and research and development projects. The

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seller is reimbursed for all allowable costs incurred during
the project, including direct and indirect expenses. In
addition to covering costs, a fixed fee is added to the total
cost as profit. This fee does not change regardless of the
actual costs incurred. The fixed fee is predetermined and
specified in the contract.
Formula: Selling Price = Total Costs + Fixed Fee
3. Cost-Plus Percentage of Cost Pricing is a pricing strategy
where a business calculates the selling price of a product or
service by adding a percentage markup to the total costs
incurred. This approach is often used in industries like

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construction, manufacturing, and custom projects, where
costs can vary significantly. Similar to other cost-based pricing
methods, total costs include both fixed and variable costs
associated with production. A predetermined percentage is
applied to the total costs to determine the profit margin. This
percentage is specified in the contract or pricing agreement.
Formula:
Selling Price = Total Cost + (Total Cost × Markup Percentage)
4. Target Costing is a pricing strategy that focuses on managing
costs to achieve a desired profit margin based on competitive
market prices. This approach starts with the selling price that
customers are willing to pay and works backward to determine

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the maximum allowable cost for a product or service. Begins
with market research to identify the target selling price based
on customer expectations and competitor pricing. Once the
target price is established, the company calculates the desired
profit margin and subtracts it from the target price to
determine the maximum allowable cost. his encourages teams
to identify ways to reduce costs without compromising quality.
Formula:
Target Cost = Target Selling Price - Desired Margin
5. Activity-Based Costing (ABC) with Cost-Plus Pricing combined with
Cost-Plus Pricing is a sophisticated approach that enhances
traditional cost-plus pricing by providing a more accurate
allocation of overhead and indirect costs to products or services.

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This method helps businesses identify the true cost of their
offerings and set prices more effectively. ABC starts by identifying
specific activities involved in production or service delivery (e.g.,
machine setup, quality inspections, customer service). Costs are
assigned to these activities based on their actual consumption of
resources, allowing for a more precise understanding of overhead
costs.
Formula: Selling Price = Total Cost (from ABC) + (Total Cost (from
ABC) x Markup
3.2 Break-even Analysis
Break-even analysis is a financial tool used to determine the
point at which total revenues equal total costs, meaning the
business neither makes a profit nor incurs a loss. This analysis helps

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businesses understand the minimum sales volume needed to cover
costs and can guide pricing, budgeting, and financial planning
decisions.
Key Components:
1. Fixed costs – costs that do not change with the level of
production or sales, such as rent, salaries, and insurance.
2. Variable costs – costs that fluctuate with production volume,
such as materials and labor directly tied to the production of
goods.
3. Selling Price per Unit – the amount charged to customers
for each unit sold.
Break-even point formula:
The break-even point (BEP) can be calculated using the

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following formulas:
a. In Units: Fixed Costs
BEP (units) = Selling Price per Unit – Variable Cost per Unit

b. In Revenue:
BEP (revenue) = BEP (units) × Selling Price per Unit
Example:
1. Determine Cost
• Fixed Costs: ₱50,000
• Variable Cost per Unit: ₱20

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• Selling Price per Unit: ₱50
2. Calculate Break-Even Point in Units:
50, 000 = 50, 000 = 1, 667 units
BEP (units) = 50 – 20 30
3. Calculate Break-Even Point in Units:
BEP (revenue) = 1,667 × 50 = 83,333
When to Use Break-Even Analysis?
• During the planning phase of a new product or
business venture.
• When evaluating the impact of cost changes or pricing

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strategies.
• To assess the financial viability of projects or
investments.
Break-even analysis is a valuable tool for businesses to
understand their cost structure and the sales volume
required to become profitable, making it an essential part of
financial planning and strategy.
3.3 Pricing Based on Cost Structures and Margins
Pricing based on cost structures and margins involves
setting prices for products or services by analyzing various costs
and determining the desired profit margins. This approach

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ensures that businesses cover their costs while achieving
financial goals. Here’s a breakdown of how this process works:
1. Cost Structures – fixed costs, variable costs, total costs
2. Desired Profit margin – this is the percentage of profit a
business aims to achieve over the costs. It can be
expressed as: Selling Price − Total Cost​
Profit Margin = Selling Price
 Pricing based on cost structures and margins is
essential for sustainable business operations. By
understanding costs and desired profit margins,
businesses can set prices that ensure profitability while
remaining competitive in the market. Balancing these
elements with market demand and customer willingness
to pay is crucial for effective pricing strategies.
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Activity No.4: Calculate Pricing Based on Cost Data
Directions: Perform the following:
1. Using the provided data, calculate the total cost of
producing one unit of the product using the following
formula:
• Total Fixed Costs: 10,000
• Expected Monthly Sales Volume: 1,000 units
• Variable Cost per Unit: 5
2. After calculating the total cost per unit, determine the
selling price per unit by applying the desired profit
margin 25%, using the formula:
Selling Price = Total Cost per Unit × (1 + Markup Percentage)
Activity No.5: Break-even Analysis Exercise
Directions: Perform the following:
1. Using the provided data, calculate the break-even point
using the following formula:
• Fixed Costs: 15,000
• Variable Cost per Unit: 10
• Selling Price per Unit: 25
2. After calculating the break-even point, calculate the
break-even revenue using the formula:
 Column A Column B
1. It is a pricing strategy where a business calculates a. Activity-based Costing
the selling price of a product or service by adding a b. Break-even Analysis
percentage markup to the total costs incurred. c. Cost-based Pricing
2. It is a sophisticated approach that enhances d. Cost-plus Pricing
traditional cost-plus pricing by providing a more e. Cost-plus fixed fee
accurate allocation of overhead and indirect costs f. Cost-plus percentage
g. Cost structures
to products or services. h. Desired Profit Margin
3. It is a pricing strategy commonly used in i. Fixed costs
industries where the costs of production can j. Markup
fluctuate significantly, such as construction, k. Selling price per unit
government contracting, and research and l. Simple cost-plus
development projects. m.Target costing
n. Variable costs
 Column A Column B
4. It is a straightforward pricing strategy where a a. Activity-based Costing
business determines the selling price of a product b. Break-even Analysis
by adding a specific markup to its total costs. c. Cost-based Pricing
5. It is a straightforward method where a business d. Cost-plus Pricing
determines the selling price of a product by e. Cost-plus fixed fee
adding a fixed markup to the total production f. Cost-plus percentage
g. Cost structures
costs. h. Desired Profit Margin
6. It is a predetermined amount or percentage i. Fixed costs
added to the total cost to achieve a desired profit. j. Markup
7. It is a financial tool used to determine the point k. Selling price per unit
at which total revenues equal total costs, l. Simple cost-plus
meaning the business neither makes a profit nor m.Target costing
incurs a loss. n. Variable costs
 Column A Column B
8. It is a pricing strategy where a business sets the a. Activity-based Costing
price of its products or services based on the b. Break-even Analysis
costs incurred in producing them, plus a markup c. Cost-based Pricing
for profit. d. Cost-plus Pricing
9. Fixed costs, variable costs, total costs. e. Cost-plus fixed fee
10. The amount charged to customers for each f. Cost-plus percentage
unit sold. g. Cost structures
11. This is the percentage of profit a business h. Desired Profit Margin
aims to achieve over the cost. i. Fixed costs
12. These are costs that do not change with the j. Markup
level of production or sales, such as rent, salaries, k. Selling price per unit
and insurance. l. Simple cost-plus
m.Target costing
n. Variable costs
 Column A Column B
13. It is a pricing strategy that focuses on a. Activity-based Costing
managing costs to achieve a desired profit b. Break-even Analysis
margin based on competitive market prices. c. Cost-based Pricing
14. These are costs that fluctuate with d. Cost-plus Pricing
production volume, such as materials and e. Cost-plus fixed fee
labor directly tied to the production of goods. f. Cost-plus percentage
g. Cost structures
15. It commonly used in manufacturing and h. Desired Profit Margin
retail where costs can be easily tracked. i. Fixed costs
j. Markup
k. Selling price per unit
l. Simple cost-plus
m.Target costing
n. Variable costs
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I.
1. F 11.H
2. A 12.I
3. E 13.M
4. D 14.N
5. L 15.L
6. J
7. B
8. C
9. G
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