Paul Pecos' pricing decision and cost-volume-profit analysis at Pecos Printers

Accounting for Business Decision Making

Evaluate Paul Pecos' decision rule

Pecos Printers, Inc., just like other companies, must earn profit to stay in the game, afford inflation and keep its business operating. As founder and CEO of the Company, Mr. Paul Pecos wanted to earn and maximize its profit.

Pecos Printers, Inc. made a bold but good move in introducing new product in the market. PP7500 is a competitive product which may equal or exceed the competitors'. To strengthen the move, Pecos did right in strategizing market penetration by considering offering lower price to distributors.

Peco's controller, Mr. Ledger, made an analysis of $295 unit cost composing of $245 variable cost and $50 fixed cost. It was mentioned that estimated total fixed cost for the year would amount to $475,000 with 15,000 projected production and 20,000 maximum production capacity.

Mr. Pecos-based PP7500's selling price on Mr. Leger's cost analysis. With the figures presented, he believed that to earn target income, the Company would need to sell the unit for $300 and up. However, there are certain points the Mr. Ledger failed to consider in analyzing the cost-volume-profit relationship.

The following are certain points Mr. Ledger was not able to consider:

475,000 fixed cost

At a level of up to 20,000 units produced, total fixed cost would not change.

In Mr. Ledger's computation, estimated fixed cost is at $50 a unit. He based the computation at 9,500 ($475,000 divided by $50) production.

Fixed cost can be computed as follows:

Assuming that $475,000 fixed cost is spread out evenly during the year, fixed cost can be computed at $39,583.33 monthly or 31.6666 per unit*.

475,000 / 15,000** units = 31.6666 fixed cost per unit assumption: total 15,000 units to be produced during the year

Sale of a unit to at least $300

As a result of the over estimation of fixed cost per unit, the approved selling price by Mr. Pecos is higher. Unit cost is lower than previous estimation:

Mr. Ledger's Computation

New Computation

Variable Cost

Fixed Cost

Total Cost per Unit

The Company could have accepted orders below $300, increase its sales volume and still generate profit. At a lower selling price, distributors would be enticed to purchase more units.

Other recommendations to improve operations

The usefulness of cost-volume-profit analysis as a planning and deciding tool depends on Management's estimates about future conditions. Manager's attitude toward risk-return relationship influences decision of Company's planned and target cost and income.

With this note, I would suggest serious reevaluation of Mr. Ledger's analysis. Management's assumption may make or break the Company's success in budgeting its cost and maximizing profit. With previous illustration, we have shown how critical cost estimates can be in management's analysis and decision. It can result to lost opportunity of earning higher income or higher sales volume.

Additional suggestion is for the Company to evaluate its capacity to provide commissions or incentives to its sales team or employee. It maybe a great motivation or drive for the employees to perform at their best capacity.

Another suggestion is to cascade a uniform sales price to the distributors. The distributors might compare its buying price with another distributor and those with higher price may demand adjustment to lower price. This could cause dispute or even loss of possible customers.

Support Computation for Requirement 3

COMPUTATION

Fixed Cost for the year

Variable Cost of units

Amount

SAM SMOOTHTALK

HARRY HUSTLER

GARRY GIFOFGAB

GLENDA GOODPERSON

Contribution Margin (following Mr. Pecos' requirement - Sales price must be $300 and up) of units

SP per Unit

SAM SMOOTHTALK

HARRY HUSTLER

GARRY GIFOFGAB

Total Sales

Variable Cost (925 units x $245)

226,625.00)

Fixed Cost

Income

Contribution Margin (Writer's Recommendation to accept orders with SP $280 and up) of units

Amount

Total SP

SAM SMOOTHTALK

HARRY HUSTLER

GARRY GIFOFGAB

GLENDA GOODPERSON

Total Sales

Variable Cost (1,925 units x $245)

471,625.00)

Fixed Cost

Income