11.3 Pricing Flashcards
Which one of the following phases of a product’s life cycle do sales continue to increase but at a decreasing rate, while prices fall, and product differentiation is no longer important?
A. Growth phase.
B. Decline phase.
C. Maturity phase.
D. Introduction phase.
C. Maturity phase.
In the maturity phase of the product life cycle, sales peak but growth declines. Competitors are numerous, thus leading to falling prices. Product differentiation is not particularly important because many dealers are producing the same item.
A company provides contracted bookkeeping services. The company has annual fixed costs of $100,000 and variable costs of $6 per hour. This year the company budgeted 50,000 hours of bookkeeping services. The company prices its services at full cost and uses a cost-plus pricing approach. The company developed a billing price of $9 per hour. The company’s markup level would be
A. 33.3%
B. 66.6%
C. 50.0%
D. 12.5%
D. 12.5%
Markup is the ratio of per-unit operating income to per-unit cost. The variable cost of a unit is $6 and the fixed cost is $2 ($100,000 total ÷ 50,000 units). Thus, the full cost of a single unit is $8 ($6 + $2), and the operating income is $1 ($9 selling price – $8 cost). The company’s markup is therefore 12.5% ($1 ÷ $8).
Which one of the following pricing methods takes into consideration a product’s entire life cycle?
A. Market-based pricing.
B. Transfer pricing.
C. Target pricing.
D. Cost-based pricing.
C. Target pricing.
A target price is the expected market price for a product or service, given the company’s knowledge of its consumers’ perceptions of value and competitors’ responses. Subtracting the unit target operating income determines the long-term unit target cost. Relevant costs are all future value-chain costs, whether variable or fixed.
Product X was launched 10 years ago as an innovative product. The initial price was relatively high, which yielded a high profit margin. The market for Product X is now becoming very competitive, and demand for the product is slowing. What pricing strategy should the company follow for Product X based on the current market conditions?
A. Prices should be held steady with only inflation adjustments.
B. Because of the increased competition, Product X’s price should be decreased.
C. The company should sell Product X below cost so that it can force competitors out of the market.
D. Pricing for Product X should be at its highest level to recoup its innovation R&D
B. Because of the increased competition, Product X’s price should be decreased.
When competition increases, market participants often target price as a distinguishing factor of their product. They will attempt to set the price of their product as low as possible in the hopes of driving out weaker competition. However, setting the price is a delicate balance because the price should be low enough to encourage purchases from customers but also high enough that the company is able to maintain operations in both the short and long term. Therefore, Product X’s price should be decreased.
The management of a company is attempting to reduce the cost for Product X by analyzing the trade-offs between different types of product features and total product cost. What type of cost reduction strategy is the company using?
A. Total quality management.
B. Value engineering.
C. Activity-based costing.
D. Kaizen.
B. Value engineering.
Value engineering is a means of reaching targeted cost levels. It is a Systematic evaluation of the trade-offs between product functionality and product cost while still satisfying customer needs.
In target costing,
A. Only raw materials cannot exceed a threshold target.
B. Only raw materials, labor, and variable overhead cannot exceed a threshold target.
C. The market price of the product is taken as a given.
D. Raw materials are recorded directly to cost of goods sold.
C. The market price of the product is taken as a given.
Target costing begins with a target price, which is the expected market price given the company’s knowledge of its customers and competitors. Subtracting the unit target profit margin determines the long-term target cost. If this cost is lower than the full cost, the company may need to adopt comprehensive cost-cutting measures. For example, in the furniture industry, certain price points are popular with buyers: a couch might sell better at $400 than at $200 because consumers question the quality of a $200 couch and thus will not buy the lower-priced item. The result is that furniture manufacturers view $400 as the target price of a couch, and the cost must be lower.
A firm is introducing a new product. Management considers the sales life cycle to strategically determine pricing on this innovative product. They decide to price the new product low to generate excitement. Which one of the following pricing approaches did management implement?
A. Price skimming.
B. Market-based pricing.
C. Cost-based pricing.
D. Penetration pricing.
D. Penetration pricing.
Penetration pricing is the practice of setting an introductory price relatively low to gain deep market penetration quickly.
Which of the following price adjustment strategies is designed to stabilize production for the selling firm?
A. Quantity discounts.
B. Functional discounts.
C. Seasonal discounts.
D. Cash discounts.
C. Seasonal discounts.
Seasonal discounts are designed to smooth production by the selling firm. For example, a ski manufacturer offers seasonal discounts to retailers in the spring and summer to encourage early ordering.
A firm in which of the following industries is most likely to use a market-based as opposed to a cost-based approach to pricing decisions?
A. Competitive market, competitors’ products dissimilar.
B. Non-competitive market, competitors’ products dissimilar.
C. Non-competitive market, competitors’ products similar.
D. Competitive market, competitors’ products similar.
D. Competitive market, competitors’ products similar.
Market-based pricing involves basing prices on the product’s perceived value and competitors’ actions rather than on the seller’s cost. Market-based pricing is typical when there are many competitors and the product is undifferentiated.
A software development company is in the process of implementing target costing for a new graphic design application. The senior leadership of the company determined the market price and desired profit for the new graphic design application. Subsequently, the controller calculated the target cost. If the estimated production cost is greater than the target cost, what is the most appropriate next step for the software development company?
A. To apply value engineering.
B. To review competitor data.
C. To use operational control.
D. To determine customer demand.
A. To apply value engineering.
A target price is the expected market price for a product or service. Once the target price is known, the company can determine a target cost that will result in the desired profit level. If the target cost cannot be achieved, the company may abandon the product. In other words, raising the price is not considered an option; the desired cost level must be achieved for production to continue. The alternative to product abandonment is some form of comprehensive cost-reduction program, such as the application of value engineering. Value engineering is a means of reaching targeted cost levels. It is a systematic approach to assessing all aspects of the value chain cost buildup for a product from R&D through design, production, marketing, distribution, and customer service.
Based on potential sales of 1,000 units per year, a new product has estimated costs of $600,000. What is the target price to obtain a 20% return on sales?
A. $750
B. $3,000
C. $1,080
D. $720
A. $750
If the company wants a 20% return on sales, the $600,000 of costs represent 80% of the selling price. Dividing $600,000 by .8 results in a total selling price of $750,000, or $750 per unit.
Buyer-based pricing involves
A. Determining the price at which the product will earn a target profit.
B. Basing prices on the product’s perceived value.
C. Basing prices on competitors’ prices.
D. Adding a standard markup to the cost of the product.
B. Basing prices on the product’s perceived value.
Buyer-based pricing involves basing prices on the product’s perceived value rather than on the seller’s cost. Nonprice variables in the marketing mix augment the perceived value. For example, a cup of coffee may have a higher price at an expensive restaurant than at a fast food outlet.
Several surveys point out that most managers use full product costs, including unit fixed costs and unit variable costs, in developing cost-based pricing. Which one of the following is least associated with cost-based pricing?
A. Price justification.
B. Target pricing.
C. Price stability.
D. Fixed-cost recovery.
B. Target pricing.
A target price is the expected market price of a product, given the company’s knowledge of its customers and competitors. Hence, under target pricing, the sales price is known before the product is developed. Subtracting the unit target profit margin determines the long-term unit target cost. If cost-cutting measures do not permit the product to be made at or below the target cost, it will be abandoned.
Companies that manufacture made-to-order industrial equipment typically use which one of the following?
A. Market-based pricing.
B. Material-based pricing.
C. Cost-based pricing.
D. Price discrimination.
C. Cost-based pricing.
A situation involving a job costing system (i.e., a made-to-order product) would be most conducive to the use of a cost-based pricing approach. The other alternatives involve standard products being sold to new types of customers.
In which product-mix pricing strategy is it appropriate for the seller to accept any price that exceeds the storage and delivery costs for the product?
A. Optional-product pricing.
B. By-product pricing.
C. Product-bundling pricing.
D. Captive-product pricing.
B. By-product pricing.
A by-product is a product of relatively minor importance generated during the production of one or more other products. Its production entails no additional costs. Any amount received above the storage and delivery costs for a by-product allows the seller to reduce the main product’s price to make it more competitive.
If a U.S. manufacturer’s price in the U.S. market is below an appropriate measure of costs and the seller has a reasonable prospect of recovering the resulting loss in the future through higher prices or a greater market share, the seller has engaged in
A. Price discrimination.
B. Dumping.
C. Predatory pricing.
D. Collusive pricing.
C. Predatory pricing.
Predatory pricing is intentionally pricing below cost to eliminate competition and reduce supply. Federal statutes and many state law prohibit the practice. The U.S. Supreme Court has held that pricing is predatory when two conditions are met: (1) The seller’s price is below “an appropriate measure of its costs,” and (2) it has a reasonable prospect of recovering the resulting loss through higher prices or greater market share.
A manufacturer produces portable televisions. The manufacturer’s product manager proposes to increase the cost structure by adding voice-activated volume/channel controls to the television, and also adding three additional repair personnel to deal with products returned due to defects. Are these costs value-added or nonvalue-added?
A. The costs of voice-activated controls and the costs of repair personnel are value-added costs.
B. The costs of voice-activated controls and the cost of repair personnel are nonvalue-added costs.
C. The costs of voice-activated controls are value-added costs, and the cost of repair personnel are nonvalue-added costs.
D. The costs of voice-activated controls are nonvalue-added costs, and the cost of repair personnel are value-added costs.
C. The costs of voice-activated controls are value-added costs, and the cost of repair personnel are nonvalue-added costs.
The additional cost of the voice-activated controls is a value-added cost because it provides new functionality for the consumer. The cost of additional repair personnel, on the other hand, is nonvalue-added since it is incurred to address deficiencies in quality.
A company’s product has an expected 4-year life cycle from research, development, and design through its withdrawal from the market. Budgeted costs are
Upstream costs (R&D, design) $2,000,000
Manufacturing costs 3,000,000
Downstream costs (marketing,
distribution, customer service) 1,200,000
After-purchase costs 1,000,000
The company plans to produce 200,000 units and price the product at 125% of the whole-life unit cost. Thus, the budgeted unit selling price is
A. $15
B. $36
C. $31
D. $45
D. $45
Whole-life costs include after-purchase costs (operating, support, repair, and disposal) incurred by customers as well as life-cycle costs (R&D, design, manufacturing, marketing, distribution, and research). Hence, the budgeted unit whole-life cost is $36 [($2,000,000 + $3,000,000 + $1,200,000 + $1,000,000) ÷ 200,000 units], and the budgeted unit selling price is $45 ($36 × 125%).
A company prices its main product by adding 30% to the manufacturing cost per unit. The company’s variable manufacturing costs are $12 per unit, variable selling and administrative costs are $1 per unit, and fixed manufacturing costs per quarter total $2,000,000. Anticipated quarterly sales were 50,000 units. The company’s market has become more competitive with similar companies offering a selling price of $60 per unit. This has resulted in decreased demand for the company’s product, causing actual quarterly sales to be 40,000 units. The company’s selling price per unit for the next quarter should be
A. $67.60
B. $80.60
C. $60.00
D. $63.00
C. $60.00
The company should price its main product at $60.00 per unit to be more competitive with its competition.
Which one of the following pricing methods focuses on setting the price based on recouping the manufacturing cost of the product and achieving a desired profit?
A. Target pricing.
B. Life-cycle based pricing.
C. Cost-based pricing.
D. Market-based pricing.
C. Cost-based pricing.
The cost-based pricing process begins with a cost determination followed by setting a price that will recover the value chain (i.e., manufacturing) costs and provide the desired return on investment.
Target pricing
A. Is more effective when applied to mature, long-established products.
B. Considers short-term variable costs and excludes fixed costs.
C. Is a pricing strategy used to create competitive advantage.
D. Is often used when costs are difficult to control.
C. Is a pricing strategy used to create competitive advantage.
Target pricing and costing may result in a competitive advantage because it is a customer-oriented approach that focuses on what products can be sold at what prices. It is also advantageous because it emphasizes control of costs prior to their being locked in during the early links in the value chain. The company sets a target price for a potential product reflecting what it believes consumers will pay and competitors will do. After subtracting the desired profit margin, the long-run target cost is known. If current costs are too high to allow an acceptable profit, cost-cutting measures are implemented or the product is abandoned. The assumption is that the target price is a constraint.
A start-up company wants to use cost-based pricing for its only product, a unique new video game. The company expects to sell 10,000 units in the upcoming year. Variable costs will be $65 per unit and annual fixed operating costs (including depreciation) amount to $80,000. The company’s balance sheet is as follows:
Assets
Current assets $100,000
Plant & equipment 425,000
Liabilities & Equity
Accounts payable $ 25,000
Debt 200,000
Equity 300,000
If the company wants to earn a 20% return on equity, at what price should it sell the new product?
A. $81.00
B. $79.00
C. $78.60
D. $75.00
B. $79.00
The net income the company will require is calculated as follows:
Return on equity = Net income ÷ Equity
Net income = Equity × Return on equity
= $300,000 × 20%
= $60,000
The necessary selling price can then be derived:
Net income = [(Selling price – Variable costs) × Units sold] – Fixed costs
Selling price = (Net income + Fixed costs + Variable costs) ÷ Units sold
= ($60,000 + $80,000 + $650,000) ÷ 10,000
= $790,000 ÷ 10,000
= $79 per unit
A firm is using cost-based pricing to determine the selling price for its new product based on the following information.
Annual volume 25,000 units
Fixed costs $700,000 per year
Variable costs $200 per unit
Plant investment $3,000,000
Working capital $1,000,000
Effective tax rate 40%
The target price that the firm needs to set for the new product to achieve a 15% after-tax return on investment (ROI) would be
A. $228
B. $238
C. $268
D. $25
C. $268
A 15% after-tax return on investment requires net income of $600,000 ($4,000,000 invested capital × .15). Per-unit net income must therefore be $24 ($600,000 ÷ 25,000 units). Per-unit operating income must be $40 [$24 net income ÷ (1.0 – .40 tax rate)]. Per-unit fixed cost in the firm’s relevant range is $28 ($700,000 ÷ 25,000 units), so per-unit contribution margin must be $68 ($40 + $28). Per-unit variable costs are given as $200, so the selling price necessary to generate the desired return is $268 ($200 + $68).
Which one of the following is the least relevant factor to consider when determining the target cost for a new product line?
A. The selling price of existing product lines.
B. Possible new manufacturing technologies that can achieve higher productivity.
C. The desired profit that the company wants to achieve.
D. The market price of competitive products.
A. The selling price of existing product lines.
The target cost is that cost level which must be achieved for a company to make a profit when a target price has been established. If the target cost cannot be achieved, then the product will be abandoned. In other words, there is no option to increase the selling price of the product to achieve the desired profit. The selling price of existing product lines would not be a factor in the target cost of a new product.
