The paper is based on a fictitious case study of Pringly Division. The firm has to make a pricing decision for a new product. Two different pricing levels are assessed, with a break even analysis and an assessment of the sales needed in order to reach a desired profit level. The calculations are used to make a recommendation on pricing.
¶ … Costing Case Study
The managers at Pringly Division need to make a decision regarding the pricing of a new product. There are two strategies suggested; the first is for the product to be sold at $170, the second strategy is to increase the marketing and increase the price. In both cases, the firm has a requirement that they will make a $4,000,000 profit. In order to assess which is likely to provide the best opportunity for Pringly each of the pricing strategies may be assessed individually, looking at the number of units required to break even, and then at the number of units that need to be sold to realize the desired level of profit.
$170 Selling Price
If the product is sold at a $170 price, there will be a total of $200,000,000 in fixed costs. Knowing that the variable cost per unit is $30, one can work out the contrition per unit and then how many units need to be sold to break even. This calculation is shown in table
Table 1; Break even point at $170 price
Selling price per unit (a)
Variable cost per unit (b)
Contribution per unit (c) (a-b)
Fixed costs (d)
20,000,000
Unit sales to break even (d/c)
142,857.1429
This shows that 142,858 is the break even point, the unit sales are rounded up, as one cannot sell a fraction of a unit. From this is appears safe that the firm will not make a loss on this products as the probability indicates this level of sales is very comfortable. However, the firm does not want to just break even, they also want to make a profit. For this it is necessary to make an adjustment and add the required profit onto the fixed costs, for the money that needs to be generated by the contribution.
Table 2; $4 million profit level at selling price of $170
Selling price per unit (a)
Variable cost per unit (b)
30
Contribution per unit (c) (a-b)
Fixed costs (d)
20,000,000
Required profit (e)
4,000,000
Total contributions required (f) (d+e)
24,000,000
Unit sales to break even (f/c)
171,428.5714
To achieve the desired profit level the firm would need to sell a total of 171,429 units. This is not as comfortable, but according to the probability with 0.5 that 180,000 units could be sold, this is not unreasonable.
The safety margin, which is the upper sales level at the profit desired point, less the break even point has been shown in table 3. This indicates the level of sales (in both units and dollars) that the firm has in terms of a safety margin from the desired point before the product will start to result in a loss.
Table 3; Margin of safety at $170 price point
Units
Revenue
Break even point
145,858
24,795,860
Desired profit level
171,429
29,142,930
Margin of safety
25,571
4,347,070
With an assessment at the $170 pricing point, the next stage is to look at the situation with a pricing point of $200 per unit.
$200 Selling Price
With a $200 selling price per unit the annual fixed costs increase to $25,000,000. The same calculation can be undertaken to assess the break even point and the sales needed to reach the desired profit level.
Table 4; Break even point at selling price $200
Selling price per unit (a)
Variable cost per unit (b)
30
Contribution per unit (c) (a-b)
Fixed costs
25,000,000
Unit sales to break even
178,571.4286
This gives a break even point of 178,571, as the result needs to be rounded up to account for whole units. Next the sales needed for the desired profit level can be calculated.
Table 5; Sales for desired profit level at $200 price
Selling price per unit (a)
Variable cost per unit (b)
30
Contribution per unit (c) (a-b)
Fixed costs (d)
25,000,000
Required profit (e)
4,000,000
Total contributions required (f) (d+e)
29,000,000
Unit sales to break even
207,142.8571
To achieve the desired profit level, the firm would have to achieve sales of 207,143 units.
The safety margin can also be calculated in units and revenue.
Table 6; Safety Margin
Units
Revenue
Break even point
178,572
30,357,240
Desired profit level
207,143
35,214,310
Margin of safety
28,571
4,857,070
Assessment
Given that there is only a probability of 0.25 that sales will reach 200,000, it would appear that the plan to increase marketing and increase the price is less likely to help the firm obtain the profits they want. When the price increases there is the chance that this will decrease demand (as this does not appear to be a Giffin good). However, increasing the marketing may also stimulate demand. However, in the figures given, the optimal solution appears to be the $170 price level, as the firm has a greater chance that the sales level for the $4 million profit will be achieved and the company should go ahead with the product at this pricing point.
Alternate assessment methods
When a product is one of a large range of product, the same approach may hot always be effective, especially where the sale of one product may rely on another, or where the fixed costs are difficult to allocate accurately or are shared between different products, in these cases one may be better using a marginal costing approach. However, it is still a useful calculation to give the firm insight into pricing decisions and the impact on profit.
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