Question 1

Calculation of cost-plus selling price and evaluation of pricing decisions

Phakoe Innovations manufactures two products DUD and FUG in departments dedicated
exclusively to them. There are also three service departments: stores, maintenance and
administration. No stocks are held as the products deteriorate rapidly. Direct costs of the
products, which are variable in the context of the whole business, are identified to each
department. The step-wise apportionment of service department costs to the manufacturing
departments is based on estimates of the usage of the service provided. These are expressed
as percentages and assumed to be reliable over the current capacity range. The general
factory overheads of M3.6m, which are fixed, are apportioned on the basis of floor space
occupied. The company establishes product costs based on budgeted volume and marks up
these costs by 25% per cent in order to set target selling prices.

Extracts from the budgets for the forthcoming year are provided below:

Annual volume (units)

DUD FUG____
Max capacity 200 000 100 000
Budget 150 000 70 000

DUD FUG Stores Maintenance Admin

Costs (Mm)
Material 1.8 0.7 0.1 0.1
Other variable 0.8 0.5 0.1 0.2 0.2

DUD FUG Stores Maintenance Admin

Departmental usage (%)

Maintenance 50 25 25
Administration 40 30 20 10
Stores 60 40
Floor space (sq m) 640 480 240 80 160

Required

Working may be M000 with unit prices to the nearest penny.

(a) Calculate the budgeted selling price of one unit of DUD and FUG based on the usual
mark up. (5marks)
(b) Discuss how the company may respond to each of the following independent event,
which represents additional business opportunities.
(i) An enquiry from an overseas customer for 3 000 units only of FUG where a
price of M35 per unit is offered;
 (ii) An enquiry for 50 000 units of FUG to be supplied in full at regular intervals
during the forthcoming year at a price which is equivalent to full cost plus 10
per cent. (5marks)

In both cases, support your discussion with calculations and comment on any
assumption or matters on which you would seek clarification. (11marks)

(c) Explain the implications of preparing product full costs based on maximum capacity
rather than the annual budget volume. (4marks)

Question 2

Pricing decision based on price/demand relationships and impact of product life cycle
stages

A manufacturer of electrical appliances is continually reviewing its product range and

enhancing its existing products by developing new models to satisfy 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.

Currently the company is reviewing three products:

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 20 weeks. Each unit has a
variable cost of M38 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 market research into the level of weekly demand at
alternative prices:

Selling price per unit M100 M85 M80 M75

Weekly demand (Units) 600 800 1 200 1 400

Product L was introduced to the market two months ago using a penetrating 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 M45 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 M100 per unit demand is expected to
be 1 000 units per week. For every M10 increase in selling price the weekly demand will
reduce by 200 units and for every M10 decrease in selling price the weekly demand will
increase by 200 units.

Product M is currently being tested and is to be launched in ten weeks’ time. This innovative
product which the company believes it will change the entire market. The company has
decided to use a market skimming approach to pricing this product during its introduction
stage.
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) (i) Calculate which of the four selling prices should be charged for product K, in order
to maximise its contribution during its maturity stage. (3marks)

As a result, in order to utilise all of the spare capacity from your answer to (i) above:
((ii) Calculate the selling price of product L during its growth stage. (6marks)

(b) Compare and contrast penetration and skimming pricing strategies during the
introduction stage, using product M to illustrate your answer. (6marks)

(c) Explain with reasons, for each of the remaining stages of M’s product life cycle, the
changes that would be expected in the
(i) Average unit production cost
(ii) Unit selling price (10marks)

Question 3

Advanced calculation of optimal selling price and profit using differential calculus

PQ is reviewing the selling price of one of its products. The current selling price of the
product is M45 per unit and annual demand is forecast to be 130 000 units at this price.
Market research shows that the level of demand would be affected by any change in selling
price. Demand analysis of this research shows that for every M1 increase in selling price the
weekly demand will reduce by 10 000 units and for every M1 decrease in selling price the
weekly demand will increase by 10 000 units.

A forecast of costs that would be incurred by PQ in respect of this product at differing

activity levels is as follows:

Activity 100 000 160 000 200 000

and sales (Units)

M000 M000 M000

Direct materials 280 448 560
Direct labour 780 1 248 1 560
Variable overhead 815 1 304 1 630
Fixed overhead 360 360 360

The company seeks your help in determining the optimum selling price to maximise its
profits.
Required:

(a) Calculate the optimum forecast annual profit from the product. (6marks)

(b) Explain the effect on the optimal price and quantity sold of independent changes to :

(i) The direct material cost per unit (2marks)

(ii) The annual fixed overhead cost (2marks)

Note: if Price (P) = a – bx then Marginal Revenue = a – 2bx

(Total 10 marks)

Question 4

Advanced: calculation of optimum selling prices using differential calculus

Palesa Nteke has budgeted that output and sales of his single product, Biks, will be100 000
for the forthcoming year. At this level of activity his unit variable costs are budgeted to be
M50 and his unit fixed costs M25. His sales manager estimates that the demand for Biks
would increase by 1 000 units for every decrease of M1 in unit selling price (and vice versa),
and that at a unit selling price of M200 demand would be nil.

Information about two price increase has just been received from suppliers. One is for
material (which are included in Palesa’s variable costs), and one is for fuel (which is included
in his fixed costs). Their effect will be to increase both the variable costs and fixed costs by
20 per cent in total over the budgeted figures.

Palesa Nteke aims to maximise profits from the product.

(a) Calculate the optimum forecast annual profits from the product. (6marks)

(b) Explain the effect on the optimal price and quantity sold of independent changes to:
(i) The direct material cost per unit (2marks)

(ii) The annual fixed overhead (2marks)

(Total 10 marks)

Note: if Price (P) = a – bx then Marginal Revenue = a – 2bx