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HANDOUT 9-PRICING DECISION-FINAL PERIOD

ACCMANA/ADVACC – 40 COPIES EACH = TOTAL COPIES 80

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 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-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.
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:

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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 Sales Demand Sales Price Sales Demand

Per Unit in Units Per Unit In Units
P10 10,000 P7 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 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 P48.00 Fixed overhead P3.00

Direct labor 12.00 Fixed selling and adm. 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. 25% mark-on based on prime cost.
2. 70% mark-on based on conversion costs.
3. 20% mark-on based on full production costs.
4. 22% mark-on based on variable production costs.
5. 20% mark-on based on full costs.
6. 24% mark-on based on variable costs.
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

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 P 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 assets (fixed capital) used in operations 900,000
Expected ratio of current assets to projected sales 30%
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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 Company’s normal sales volume is 500,000 units. The unit cost to make and sell
Exxon’s product are as follows:

Direct materials P50.00 Fixed factory overhead P15.00

Direct labor 25.00 Variable selling and adm. 8.00
Variable factory overhead 10.00 Fixed selling and adm. 7.00

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.

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