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Mwanza-Tanzania

B5: PROBLEM SOLVING

TOPIC: PRICING DECISION

Q1.A Manufacturer
A manufacturer wants to launch a new product.
The non-current assets needed for production will cost TZS 8,000 million, and working capital
requirements are estimated at TZS1,600 million.
The estimated annual sales volume is 80,000 units.
Variable production costs are TZS 60,000 per unit.
Fixed production costs will be TZS 900 million each year, and annual fixed non-production
costs will be TZS300 million.

Required:
a) Calculate selling price using
(i) Full cost plus 20%
(ii) Marginal cost plus 40%
(iii) Pricing based on a target return on an investment of 10% per year.
b) If actual sales are only 40,000 units and the selling price is set at full cost plus 20%, what
will the profit be for the year?

Q2.Maua
a) What is your understanding of the cost based pricing model?

b) In which circumstances will the business be able to use cost-based pricing?

c) Maua Company may wish to sell 500,000 units of its products in order to attain a desirable
market share. The company has some discretion to set up its price for the product it sells. If it
will attain the planned sales volume, its production costs are expected to be as follows:

TZS
Raw Materials 20
Direct Labour 12
Overhead 30
Factory Costs 62

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In addition to production costs, the company also will incur TZS.30,750,000 as administrative
costs and TZS.32,750,000 as distribution costs. The following was the financial position of the
company at the time of planning its operations:

Maua Company Limited

Budgeted Statement of Financial Position as at April 2010

TZS. TZS.

Creditors 40,592,000 Cash 500,000

interest Payable 1,200,000 Debtors 25,592,000

Loan 20,000,000 Stocks 24,200,000

Capital 151,000,000 Fixed Assets 180,000,000

Retained Earnings 16,500,000

229,292,000 229,292,000

The company appraises its projects based on the weighted average cost of capital, which
currently is equal to 12%.

Required:

Suggest a mark-up on full costs and the price that will earn the company a desired return on
capital. (20 Marks)

Q3.GER
Market research conducted by GER has revealed that the maximum demand for product A is
60,000 units each year, and that demand will decrease by 50 units for every TZS1,500 increase in
the selling price. Based on this information GER has calculated that the profit–maximising level
of sales for product A for the coming year is 45,000 units.
Required:
Determine the demand equation and the price at which these units will be sold.

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Q4. NBAA Nov 2011 –Pricing strategies
Firms intentionally set high or low price on its products with clear objectives. The objectives may
relate to earning a desired profit or attaining a desired market share or simply being able to
survive.

Required:

(i) How will the business set the price if its pricing objective is its market penetration?

(ii) How will the business set the price if its objective is market skimming?

(b) Indicate the circumstances which permit cost-based pricing.

Q5.Infinity
Infinity is a furniture manufacturing company which supplies custom-made furniture items to
Eternity Ltd, who provides office furniture to small companies as per specification. It uses two
materials: steel and wood.
It needs to complete Eternity‘s order using 1,000 tonnes of steel and 2,000 tonnes of wood.
The workforce of Infinity will have to work 4,000 hours on making the boat: 2,400 hours will be
in the assembly process and the remainder will be in the finishing (painting the desks, tables,
cupboards, etc. and other finishing tasks). Infinity will quote a price of relevant cost plus 60%.
Infinity has 400 tonnes of steel held in inventory. This originally cost TZS20,000 per tonne. It
now has a current price of TZS24,000 and could be sold for TZS16,000 per tonne. Eternity no
longer produces steel furniture and has no other use for the steel. It only produces wooden
furniture on a regular basis.
There are 800 tonnes of wood held in inventory. This originally cost TZS40,000 per tonne. It
currently has a purchase price of TZS44,000 per tonne and a selling price of TZS30,000 per
tonne. (Selling price and net realisable value can be assumed to be the same figure).
All labour is paid TZS8,000 per hour. To complete the contract on time, labour for the finishing
process will have to be transferred from other work which produces contribution at a rate of
TZS 6,000 per hour (after labour costs). There is currently a surplus capacity for assembly labour
amounting to 2,000 hours which will have to be hired on a temporary basis at a rate of TZS8,000
per hour.
Required:
c) Calculate the price Infinity will quote on the contract.
d) State any TWO limitations of cost-based pricing.

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Q6.Wince
Wince Co produces branded watches. Based on their study of production costs and demand
curve, it has determined the following demand and cost functions:
P = 80,000 – 3,000X (demand units are in thousands)
C = 1,000X2 + 20,000X + 100,000 (cost figures are in thousands)
Required:
a) Determine the level that maximizes sales revenue.
b) Determine the level that maximizes profit.
c) Determine the optimal price to maximize profits.

Q7.Vinyago CraftsWork
Vinyago Craftworks Ltd (VCL) is a newly established maker and distributor of unique mninga
sculptures. VCL
management are inexperienced in making and selling process of their mninga sculptures and
are yet to decide the selling price which will maximize both sales revenue and profit of the
company. VCL management have heard of marginalist theory, a neo – classical theory of the
firm which is based on two rules: MC = MR, the theory which is likely to help them establish
selling price for their sculptures.
You have been identified as a management consultant who could help VCL management, and
you have been provided with the following information:

(i) The cost of making the first sample of a sculpture included

Direct material 2 pieces of mninga@TZS 20000 40,000
Sculpturing labour 50 hours @TZS 1000 50,000
Variable overhead (50% of Sculpturing labour) 25,000
115,000

(ii) Budgeted fixed cost per annum include:

Rental charges TZS 50,000,000
Administration expense TZS 80,000,000
(iii) VCL management expects the Sculpturing time to gradually improve with experience
and has estimated 80% learning curve for the first 16 Sculptures, after which a steady
state production time will apply with labour time per Sculpture being equal to the 16th
Sculpture.
(iv) It has been established that, the current price of similar mninga Sculptures in the market
is TZS 120,000 and at this price 100,000 units are demanded. Experience in this market
indicate if price of similar Sculptures increase or decrease by TZS 10,000, quantity
demand will increase or decrease by 25,000 units.
(v) Currently, 20 units of mninga Sculptures have been ordered by a newly established
resort.

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 Note: The learning curve formula is Y = axb. At the learning rate of 0.8 (80%), the learning
factor (b) is equal to -0.322. All figures should be rounded off to one decimal place.
Required:
d) Determining sales maximizing selling price and the maximum sales revenue at this sales
point (4 marks)
e) Determining profit maximizing selling price and the maximum profit at this sales point
(8 marks)
f) Explain what is meant by a penetration pricing strategy and a market skimming strategy
and discuss the cases that would male VCL to use such pricing strategies when
launching their mninga sculptures (8 marks)

Q8.ALG Co Pricing and Cost Estimation) F5 June 2015

ALG Co is launching a new, innovative product onto the market and is trying to decide on the
right launch price for the product. The product’s expected life is three years. Given the high level
of costs which have been incurred in developing the product, ALG Co wants to ensure that it
sets its price at the right level and has therefore consulted a market research company to help it
do this. The research, which relates to similar but not identical products launched by other
companies, has revealed that at a price of $60, annual demand would be expected to be 250,000
units.
However, for every $2 increase in selling price, demand would be expected to fall by 2,000 units
and for every $2 decrease in selling price, demand would be expected to increase by 2,000 units.
A forecast of the annual production costs which would be incurred by ALG Co in relation to the
new product are as follows:

Annual production (units) 200,000 250,000 300,000 350,000

$ $ $ $
Direct material 2,400,000 3,000,000 3,600,000 4,200,000
Direct labour 1,200,000 1,500,000 1,800,000 2,100,000
Overheads 1,400,000 1,550,000 1,700,000 1,850,000

Required:
a) Calculate the total variable cost per unit and total fixed overheads. (3 marks)
b) Calculate the optimum (profit maximizing) selling price for the new product AND
calculate the resulting profit for the period. Note: If P = a – bx then MR = a – 2bx. (7
marks)
c) The sales director is unconvinced that the sales price calculated in (b) above is the right
one to charge on the initial launch of the product. He believes that a high price should be
charged at launch so that those customers prepared to pay a higher price for the product
can be ‘skimmed off’ first.

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 Required:
Discuss the conditions which would make market skimming a more suitable pricing
strategy for ALG, and recommend whether ALG should adopt this approach instead. (5
marks) (15 marks)

Q9.Magari Co
Magari Co. specializes in the production of a range of motor vehicles. It is about to launch a
new product, the
Kantinka‘, a unique motor vehicle which is capable of providing unprecedented levels of speed
using a minimal amount of fuel. The technology used in the Kantinka is unique, so Magari Co.
has patented it so that no competitors can enter the market within two years. The company‘s
development costs have been high and it is expected that the product will only have a five-year
life cycle.
Magari Co. is now trying to ascertain the best pricing policy that they should adopt for the
Kantinka‘s lauch onto the market. Demand is very responsive to price changes and research has
established that, for every TZS 1,500,000 increase in price, demand would be expected to fall by
1,000 units. If the company set the price at TZS 73,500,000, only 1,000 units would be demanded.

The cost of producing each motor vehicle is as follows:

TZS
Direct materials 4,200,000
Labour 1,200,000 (15 hours at TZS80,000 per hour. See note A below)
Fixed overheads 600,000 (based on producing 50,000 units per annum)
Total cost 6,000,000

Note A
The first motor vehicle took 15 hours to make and labour costs TZS80,000 per hour. A 95%
learning curve exists, in relation to production of the unit, although the learning curve is
expected to finish after making 100 units. Magari Co‘s management have said that any pricing
decisions about the Kantinka should be based on the time it takes to make the 100th unit of the
product. You have been told that the learning coefficient, b = -0.0740005.
All other costs are expected to remain the same up to the maximum demand levels.
Required:
a) Establish the demand function (equation) for motor vehicle units.
b) Calculate the marginal cost for each motor vehicle unit after adjusting the labour cost as
required by note (a) above
c) Calculate the optimum price and quantity.

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 d) Explain what is meant by a penetration pricing strategy and a market skimming strategy
and discuss whether either strategy might be suitable for Magari Co. when launching
the Kantinka.

Q10.HS
HS manufactures components for use in computers; the business operates in highly competitive
market. Where there are a large number of manufactures of similar components. The Managing
Director seeks your advice to determine the selling price that will maximize the profit to be
made during this period;
Date given:
MARKET Demand:
The current selling price is $ 1350 and at this price the average weekly demand over lat four
weeks has been 8,000 components. An analysis for the market show that for every $50 increase
in price demand will falls by 1000 components per week. Equally for every $50 reduction in
selling price, the demand will increase by 1,000 components per week.
Cost:
Direct materials is $270. The price is part of a fixed price contract with the material suppliers
and the contract does not expire for another year.

Production labour and conversion costs, together with other overheads cost and the
corresponding output volumes have been collected for the last four week and there are a
follows:

Week Volume Cost (‘’000’’)

1 9,400 7,000
2 7,600 5,688
3 8,500 6,334
4 7,300 5,446

No significant changes in cost behavior are expected over next 12 weeks.

Required
Calculate optimum selling price of the component for the period.

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Q11.Product M

Product ‘M’ is currently being tested by MKL and is to be launched in ten weeks’ time. The ‘M’
is an innovative product which the company believes will change the entire market. The
company has decided to use a market skimming approach to pricing this product during its
introduction stage.

MKL continually reviews its product range and enhances its existing products by developing
new models to satisfy the demands of its customers. The company intends to always have
products at each stage of the product life cycle to ensure the company’s continued presence in
the market.

MKL is currently reviewing its two existing flagship products, Product K and Product L. You
have been given the following information:

Product K was introduced to the market some time ago and is now about to enter the maturity
stage of its life cycle. The maturity stage is expected to last for ten weeks. Each unit has a
variable cost of $38 and takes 1 standard hour to produce. The Managing Director is unsure
which of four possible prices the company should charge during the next ten weeks. The
following table shows the results of some market research into the level of weekly demand at
alternative prices

Selling price per unit $100 $85 $80 $75

Weekly demand (units) 600 800 1,200 1,400

Product L was introduced to the market two months ago using a penetration pricing policy and
is now about to enter its growth stage. This stage is expected to last for 20 weeks. Each unit has
a variable cost of $45 and takes 1.25 standard hours to produce. Market research has indicated
that there is a linear relationship between its selling price and the number of units demanded, of
the form P = a – bx. At a selling price of $100 per unit demand is expected to be 1,000 units per
week. For every $10 increase in selling price the weekly demand will reduce by 200 units and
for every $10 decrease in selling price the weekly demand will increase by 200 units.

The company currently has a production facility which has a capacity of 2,000 standard hours
per week. This facility is being expanded but the extra capacity will not be available for ten
weeks.

Required:

a) Calculate which of the four selling prices should be charged for product K, in order to
maximize its contribution during its maturity stage;

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 b) Following on from your answer above in (a), calculate the selling price of product L
during its growth stage
c) (c) Compare and contrast penetration and skimming pricing strategies during the
introduction stage, using product M to illustrate your answer. (7 marks)

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