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HANDOUT 9-PRICING DECISION-FINAL PERIOD


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DE LA SALLE COLLEGE OF ST. BENILDE
PRICING DECISION
DEFINITIONS
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 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 set-up and charged to customers.

MAJOR FACTORS THAT INFLUENCE PRICING DECISIONS:


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 vendors 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-UP) IN ESTABLISHING SELLING


PRICE:
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.
5. Variable Costs Based on the cost of direct materials, direct labor, variable
manufacturing overhead, and variable selling and administrative expenses.

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6. Full (Total) Costs Based on the cost of materials, direct labor,
manufacturing overhead, 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 CAPITAL (INVESTMENT)


EMPLOYED:
The formulas used in this pricing technique provide a measure of the degree
of efficiency with which total assets are utilized to generate earnings for the
business.
A. Total Assets (Capital Employed) is given per problem.
Unit Selling Price = Total Cost + (Rate of Return x Capital Employed)
Sales Volume in Units
B. Plant Assets (Fixed Capital) is given per problem.
Unit Selling Price = Total Cost + (Rate of Return x Fixed Capital)
Sales Volume in Units
1 (Rate of Return x Variable Capital Ratio)

EXAMPLE PROBLEM 1 (Profit Maximization)


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
Per Unit
P10
9
8

Sales Demand
in Units
10,000
20,000
30,000

Sales Price Sales Demand


Per Unit
In Units
P7
40,000
6
50,000
5
60,000

Maxim can produce the above sales demand with its idle capacity. The
variable cost to produce and sell each unit is P4. The company will incur fixed costs
of P50,000 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.
EXAMPLE PROBLEM 2 (Mark-On on Different Bases)
The Pride Company started operations on January 1, 2008 and expected to
produce 200,000 units in its first year of operations. The cost data per unit based
on expected productions are shown below:
Direct materials
Direct labor

P48.00
Fixed overhead
12.00
Fixed selling and adm.

P3.00
2.00

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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.
2.
3.
4.
5.
6.
7.

25% mark-on based on prime cost.


70% mark-on based on conversion costs.
20% mark-on based on full production costs.
22% mark-on based on variable production costs.
20% mark-on based on full costs.
24% mark-on based on variable costs.
Assuming Pride 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 P2 per unit for shipping.
Required: Determine the unit-selling price under each independent case.

EXAMPLE PROBLEM 3
Sport Company expects to produce 150,000 units of Product X during 2004.
The sales demand is expected to be 140,000 units. The company provided the
following data.
Standard Unit Cost:
Budgeted annual fixed and
Direct material
P 8.20
administrative
expenses
P200,000
Direct labor
4.50
Total capital employed
800,000
Variable overhead
2.30
Expected rare of return
Fixed overhead
2.00
on investment
30%
Standard Product Cost
P17.00
Variable selling & adm.
P 2.50
REQUIRED: a. Compute the expected selling price.
b. Compute the expected selling price if customers are entitled to a 3%
sales discount.

EXAMPLE PROBLEM 4

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The Retain Company started operations in 2004 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
Fixed mfg. cost per unit based on normal capacity
Variable selling and administrative cost per unit
Annual fixed selling and administrative expenses
Plant assets (fixed capital) used in operations
Expected ratio of current assets to projected sales

25.40
5.20
6.60
240,000
900,000
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.

EXAMPLE PROBLEM 5
The Exxon Companys normal sales volume is 500,000 units. The unit cost to
make and sell Exxons product are as follows:
Direct materials
overhead
P15.00
Direct labor
8.00
Variable factory overhead
7.00

P50.00

Fixed factory

25.00

Variable selling and adm.

10.00

Fixed selling and adm.

Beginning 2004, replacement cost of direct material is P55 per unit, labor
contract provides an increase of 20% and variable selling costs to increase by 10%.
Sales discount averages 3% on gross sales.
REUIRED: Compute the unit-selling price to be set-up if management desires a
profit of 25% based on
full costs.
END