ABDT5104 PRICING STRATEGY
Tutorial 3 Answer
June 7, 2011
Question 1 The incremental variable cost for a change in sales is often not equal to the average variable cost. Example overtime vs. average cost production. Company A Production: 1,100 1,100 units Material cost: RM4, 400 8, 00 (regular pay)
Labor Cost: RM9, 200
1,200 (overtime)
Option 1: Determine pricing based on average variable cost:
Underpricing if demand increase.
Option 2: Determine pricing based on incremental variable cost : Material costs = Labor costs
=
Assume employee can produce 100 units during overtime hour
RM16
Hence, the result above show that, average variable cost is not equal with incremental variable cost.
Question 2 i.
AB
ii.
A
iii.
C
iv.
A=C
v.
(P1-P2)*Q = (2-1.8)*1,000 = $200
vi.
A=C=$200
vii.
(P2-vc)*Q=200 = (1.8-0.5)*Q=200 Q= 1,154 unit
viii.
The price cut will be profitable only if it results in an increase in monthly sales volume of more than 15.38%. the compan y must now sell at least 1,154 units to maintain the same level of profitability it had achieved before the price reduction.
ABDT5104 PRICING STRATEGY
Tutorial 3 Answer
June 7, 2011
Question 3 Three steps for financial analysis pricing are: 1. Determine the contribution contribution margin. This is the foundation fo r all pricing financial analysis calculations. 2. Calculate the break-even sales change for the price change. Given a price change, this is the change in sales volume require to breakeven, thus defining the point at which a price change becomes either profitable or unprofitable. 3. Calculate the profit implication of sales changes greater or less than the break -even sales change. Having defined the boundary of price change profitability, what are the profit implications of actual sales changes that are greater than the breakeven sales change calculation in step 2. That is, given a price change, if the change in sales were greater than the breakeven sales change how much addition profit would the firm realize from the price change.
Question 4 CM=40-16 =24 %breakeven sales change =
=33.33%
Units BE sale change= 0.333* 20,000 = 6,666 units 20,
i.
000 + 6, 660 = 26,666 units. The price cut will only be profitable if it results in an increase in weekly sales volume at more than 33.33%. The company must sell at least 26,666 units to maintain the same level of profitability they have achieved before price reduction otherwise it is best for the company to hold on to $40.
%breakeven sales change =
=-20%
Units BE sale change= -0.20 * 20,000 = -4,000 units 20,
ii.
000 -4, 000 = 16,000 units. The price increase will only be profitable only if it result in an reduction in weekly sales volume at less than 20%. The company must sell at least 16, 000 units to maintain the same level of profitability they have achieve before price increase, otherwise it is best for the company to hold on $40.
