5: Pricing Calculations

Question 1

What are the two things a sales price must be?

Answer 1

Low enough to encourage the purchaser to buy

High enough so the producer makes an acceptable profit

Question 2

What is cost plus pricing, and what are the types?

Answer 2

Calculating the cost of the product and adding a percentage mark-up for profit

Can use:
full cost
marginal cost

Question 3

What are the two methods to calculate full cost-plus pricing?

Answer 3

Total production cost + % mark up

Total cost + % mark up

Question 4

Ads and Dis of full cost pricing?

Answer 4

Advs:
- quick and easy
- justify price increase
- pricing decisions can be delegated
- ensures a profit

Dis:
- profit maximisation might not be achieved
- no incentive to control costs
- arbitrary absorption
- vicious circle

Question 5

What are the two costs to calculate marginal cost-plus pricing?

Answer 5

Total variable production costs + % mark up

Total variable cost + % mark up

Question 6

Ads and Dis of marginal cost-plus pricing?

Answer 6

Ads:
- simple
- avoids arbitrary apportionment of FCs
- very useful for making short term decisions

Dis:
- may make losses in the long term
- not good for businesses with heavy fixed cost base
- profit maximisation may not be achieved

Question 7

What is ROI in practical terms?

Answer 7

It is the gross profit margin

Or the targeted annual return

Or the return on investment

Question 8

Best way to approach questions on mark ups and margins?

Answer 8

Also draw out where 100% is first

For markup, Cost of Sales is 100%

For margin, selling price is 100%

Question 9

What could determine the mark up percentage a company uses?

Answer 9

Vary according to the nature of the customer

Or on the strategy being pursued

Can be a target return on investment

Applied to a range of products

Question 10

What is transfer pricing?

Answer 10

Amount charged by one part of an organisation for the provision of goods/services to another part of the same org

Question 11

Why does transfer pricing happen?

Answer 11

A signalling mechanism, to encourage divisional managers to act in a way to maximise shareholder wealth

Makes division A a profit centre, and so Division B realises A does not make goods for free!

Question 12

5 aims of transfer pricing?

Answer 12

Measure divisional profits

Measure cost and revenues

Autonomy to managers

Encourage goal congruence

Profit maximisation

Question 13

4 practical methods to determining a Transfer Price?

Answer 13

Market Price

Cost-plus Price

Two-part Transfer Price

Dual Pricing

Question 14

When and how to use market price TP?

Answer 14

In a perfectly competitive market

Optimum, providing the supplying division is operating at full capacity

Reduced for cost savings from internal transfers: packaging, advertising, distribution, irrecoverable debts

Question 15

When and how to use cost-plus price TP?

Answer 15

Works exactly the same way as cost-plus pricing

Question 16

What is the minimum TP that A will accept at full capacity?

Answer 16

At full capacity, the focus is on maximising profit.

The selling cost will be the maximum profit that can be made then out of the options. Often external seller.

Question 17

What is the maximum TP that B will pay?

Answer 17

Final sales price of product minus what B must pay as part of their process

Question 18

What is the minimum TP that A will accept at spare capacity?

Answer 18

It is selling all it can to the outside market. Can make extra goods without losing sales

Cost can be the marginal cost to make product, or if there is a competitor to B, whatever price is less than B’s competitor!

Question 19

When should Division A no longer produce product?

Answer 19

When an external supplier to B can supply the item for a selling price less than the marginal cost it costs for A

A has been undercut!

Question 20

Issues with using a cost-plus TP?

Answer 20

Pre-determined standard cost should be used, to prevent profits being distorted due to inefficiencies being transferred

TP should be based on total cost to make sure overheads are recovered

Supplying divisions fixed costs seen as variable

Supplying division may over recover fixed costs. Receiving division may then outsource purchases when optimal

Question 21

What is two part transfer pricing?

Answer 21

Accounted for in two parts:
- standard variable cost
- periodic fixed charge

Receiving division is aware of the cost behaviour patterns

Question 22

What is dual pricing?

Answer 22

Each division records TP at a different amount to encourage optimal decision making

Supplying division
- records revenue at market price, or total cost-plus

Receiving division
- records purchases a standard variable cost only