Module 4A

x Product Life Cycle Management (Stages, Life Cycle Income Statement, Postpurchase Costs)
x Market/Demand-Based Pricing (Target Costing, Price Elasticity of Demand, Profit-Maximizing Price)
x Cost-Based Pricing (Cost Plus, Time and Material Pricing)
x Special Orders and Short-Run Pricing Decisions

Module 4B
Product Bundling
Product Mix Decisions
Linear Programming
Profit-Related Variances
Product Life Cycle Management
Life Cycle Cost Development Cost + Production Cost + Logistics Cost
Whole Life Cost Life Cycle Cost + Postpurchase Cost
Life Cycle Profit Life Cycle Revenues - Life Cycle Costs
Target Cost Pre-determined Selling Price - Desired Profit

Pricing Products and Services

Selling Price Cost + Mark-up
Profit-Maximizing Price Variable Cost x (1 + Profit-Maximizing Mark-up)
Profit-Maximizing Mark-up (%) [-1 / (1 + Price Elasticity)]
Price Elasticity of Demand [Ed] ln (1 + %change in demand) / ln (1 + %change in price)
Time and Material Price Time Charges + Material Charges
Time Charges Hourly labor cost + Hourly overhead cost + Mark-up
Hourly Overhead Cost Annual Overhead / Annual Labor hours
Material Charges Material Cost + Handling and Storage Cost + Mark-up
Handling and Storage Cost Material Cost x (Total Handling and Storage Cost / Total Material Cost)
Special Order Pricing Variable Cost + Opportunity Cost
(1) Breakeven Units
Breakeven Sales (in units) = Fixed Costs / Contribution Margin
Fixed Cost
Design Costs $ 650,000
Production Costs 3,560,000
Marketing and Distribution costs 2,225,000
Total 6,435,000
Contribution Margin ($50 - $20 - $5) 25
Breakeven Sales (in units) 257,400 units

(2) Pricing Decisions

Strategy 1 Strategy 2
Life Cycle Revenues
($50 x 500,000 units) $ 25,000,000
($70 x 100,000) + ($40 x 600,000) $ 31,000,000
Sale of Rights 250,000 250,000
Sub-Total 25,250,000 31,250,000

Life Cycle Cost

Variable ($25 x 500,000 units) 12,500,000 17,500,000
Fixed Cost 6,435,000 6,435,000
Sub-Total 18,935,000 23,935,000

Life Cycle Profits 6,315,000 7,315,000

Strategy 2 is better, because it generates higher life cycle profits at $7,315,000 versus $6,315,000 (difference of $1,000,000)
(difference of $1,000,000)
(1) Total Life Cycle Cost
Fixed Variable Total
Metal extraction and processing
($4,000 x 24 months) $ 96,000
($100 x 50,000 tons) $ 5,000,000
Rent on temporary buildings ($2,000 x 27 months) 54,000
Administration ($5,000 x 27 months) 135,000
Clean-up ($30,000 x 3 months) 90,000
Land restoration 475,000
Cost of selling land 150,000
Project Life Cycle Cost 1,000,000 5,000,000 $ 6,000,000

(2) Projected Life Cycle Income Statement

Life Cycle Revenues ($150 x 50,000 tons) 7,500,000
Life Cycle Cost 6,000,000
Life Cycle Operating Income 1,500,000
Desired Life Cycle Profit ($40 x 50,000 tons) 2,000,000
Selling Price of Land $ 500,000

(3) New Life Cycle Cost

Current Life Cycle Revenues ($7.5M + 500K) 8,000,000 133.33%
Current Life Cycle Cost 6,000,000 100.00%
Current Life Cycle Profit 2,000,000 33.33%

New Life Cycle Revenues ($140 x 50,000 tons) 7,000,000

Sale of Land ($500,000 - 100,000) 400,000
Total Life Cycle Revenues 7,400,000
Desired Life Cycle Profit ($7,400,000 / 133% x 33%) 1,850,000
New Life Cycle Cost 5,550,000

Reduction in Life Cycle Cost ($6M - 5.55M) $ 450,000

(1) Target Costing
Unit Target Cost = Pre-determined Selling Price - Desired Profit
= $2,000 - ($2,000 x 10%)
= $ 1,800 per unit

Total Target Cost = $1,800 x 200 tables

= $ 360,000

Design cost $ 5,000

Direct materials 120,000
Direct manufacturing labor 142,000
Variable manufacturing overhead 64,000
Fixed manufacturing overhead 46,500
Marketing 15,000
Total cost estimate $ 392,500

No, the cost estimate does not meet Pacific's requirement ($392,500 vs target cost $360,000).
Yes, value enginerring is needed to reduce cost estimates and meet the target cost.

(2) Value Engineering

Target Cost = Predetermined Selling Price - Desired Profit
= $1,950 - ($1,950 x 10%)
= $ 1,755

Total Target Cost = $1,755 x 200 tables

= 351,000

Reduction in material costs ($120,000 x 40%) $ (48,000)

Additional design cost 6,000
Net cost reduction $ (42,000)
Original cost estimate 392,500
New cost estimate $ 350,500

Yes, the design change allows the table to meet its target cost ($350,500 vs target cost of $351,000)
Yes, once the design is finalized, the costs of materials are locked-in.

(3) Marketing Campaign

Additional marketing cost $ 7,000
Original cost estimate 392,500
New cost estimate $ 399,500

Pre-determined Selling Price $ 2,200

Number of Units to be sold 200
Estimated total revenues $ 440,000
 Total Target Cost = Pre-determined Sales - Desired Profit
= $440,000 - ($440,000 x 10%)
= $ 396,000

No, target cost will not be achieved without any value engineering ($399,500 vs target cost of $396,000)

(4) Decision Making

Value Marketing
Engineering Strategy
Revenues
($1,950 x 200) $ 390,000
($2,200 x 200) $ 440,000
Cost 350,500 399,500
Profit $ 39,500 $ 40,500

Pacific should spend on marketing as it provides higher profits than value engineering ($40,500 vs $39,500)
0 vs $39,500)
(15-28) (1) Tabulated Price, Quantity, and Revenue Data
Quantity Price Revenues Marginal
20 $ 1,000 $ 20,000 N/A
40 950 38,000 18,000
60 900 54,000 16,000
80 850 68,000 14,000
100 800 80,000 12,000

(2) Revenue Curve

Revenue Curve
$90,000
$80,000
$70,000
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$-
10 20 30 40 50 60 70 80 90 100 110

(15-29) (1) Tabulated Cost and Quantity Data

Quantity Unit Cost Total Cost Marginal
20 $ 900 $ 18,000 N/A
40 850 34,000 16,000
60 820 49,200 15,200
80 860 68,800 19,600
100 890 89,000 20,200

(2) Cost Curve

Cost Curve
$100,000
$90,000
$80,000
$70,000
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$-
10 20 30 40 50 60 70 80 90 100 110
 $60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$-
10 20 30 40 50 60 70 80 90 100 110

(15-30) (1) Tabulated Revenue, Cost, and Profit Data

Quantity Unit SP Revenues Cost Proft (Loss)
20 $ 1,000 $ 20,000 $ 18,000 $ 2,000
40 950 38,000 34,000 4,000
60 900 54,000 49,200 4,800
80 850 68,000 68,800 (800)
100 800 80,000 89,000 (9,000)

(2) Total Revenue and Cost Curves

Revenue, Cost, Profit Curves

$100,000

$80,000

$60,000

$40,000

$20,000

$-
10 20 30 40 50 60 70 80 90 100 110
$(20,000)

Revenues Cost Proft (Loss)

(3) Pricing the CD player at $900 per unit is recommended, as it generates the highes profits at $4,800.
(1) Sensitivity Analysis
Week 1 Week 2
Sales
($1.89 x 1,500 cones) $ 2,835.00
($1.49 x 2,340 cones) $ 3,486.60
Variable Costs
($0.43 x 1,500 cones) 645.00
($0.43 x 2,340 cones) 1,006.20
Fixed Costs 675.00 675.00
Profit $ 1,515.00 $ 1,805.40

Maria made more money selling the cones for $1.49, generating profits of $1,805.40 (vs $1,515).

(2) Price Elasticity of Demand

Price Elasticity (Ed) = ln(1 + %change in demand) / ln(1 + %change in price)
= ln(1 + 56%) / ln(1 - 21.16%)
= -1.87

Week 1 Week 2 Change

Demand 1,500 2,340 56.00%
Price $ 1.89 $ 1.49 -21.16%

(3) Profit-Maximizing Price

Profit-Maximizing Mark-up = [-1 / (1 + Price Elasticity)]
= [-1 / (1 - 1.87)
= 114.94%

Profit-Maximizing Price = Variable Cost x (1 + Profit-Maximizing Mark-up)

= $0.43 x (1 + 114.97%)
= $ 0.92
(A-5) (1) Sensitivity Analysis
Current New
Sales
($7.00 x 100,000 units) $ 700,000
($8.00 x 85,000 units) $ 680,000
Cost
($0.80 x 100,000 units) 80,000
($0.80 x 85,000 units) 68,000
Profits $ 620,000 $ 612,000

St. Vincent makes more money by selling souvenir sheets for $7.00, generating profits of $620,000.

(2) Price Elasticity of Demand

Price Elasticity of Demand [Ed] = ln (1 + %change in demand) / ln (1 + %change in price)
= ln (1 - 15%) / ln (1 + 14.29%)
= -1.22

Current New Change

Demand 100,000 85,000 -15.00%
Price $ 7.00 $ 8.00 14.29%

(3) Profit Maximizing Price

Profit-Maximizing Mark-up (%) = [-1 / (1 + Price Elasticity)]
= [-1 / (1 - 1.22)]
= 460.65%

Profit-Maximizing Price = Variable Cost x (1 + Profit-Maximizing Mark-up)

= $0.80 x (1 + 460.65%)
= $ 4.49

(4) Sensitivity Analysis

New Profit-Maximizing Price = New Variable Cost x (1 + Profit-Maximizing Mark-up)
= $1.00 x (1 + 460.65%)
= $ 5.61
(1) Variable manufacturing cost
Selling Price $ 400 200.00%
Cost 200 100.00%
Profit $ 200 100.00%

Selling Price = Variable Manufacturing Cost + Mark-up

$400 = $200 + ($200 x 100%)

(2) Absorption manufacturing cost

Selling Price $ 400 148.15%
Cost ($200 + 70) 270 100.00%
Profit $ 130 48.15%

Selling Price = Absorption Manufacturing Cost + Mark-up

$400 = $270 + ($270 x 48.15%)

(3) Total Cost

Selling Price $ 400 114.29%
Cost ($200 + 70 + 30 + 50) 350 100.00%
Profit $ 50 14.29%

Selling Price = Total Cost + Mark-up

$400 = $350 + ($350 + 14.29%)

(4) Total Variable Cost

Selling Price $ 400 173.91%
Cost ($200 + 30) 230 100.00%
Profit $ 170 73.91%

Selling Price = Total Variable Cost + Mark-up

$400 = $230 + ($230 x 73.91%)
(1) Formula
Time Charges = Hourly labor cost + Hourly overhead cost + Mark-up
Material Charges = Material cost + Handling and storage cost + Mark-up
= Material cost + [(Total Handling and storage cost / Total cost of materials) x material cost] + M

(2) Time and Material Pricing

Time Charges = Hourly labor cost + Hourly overhead cost + Mark-up
= $16 + ($108,000 / 12,000 hours) + $4
= $ 29

Total Time Charges = $29 x 400

= $ 11,600

Material Charges = Material cost + [(Total Handling and storage cost / Total cost of materials) x material cost] + M
= $60,000 + [(25,000/250,000) x $60,000] + 0
= $ 66,000

Time and Material Price = Time Charges + Material Charges

= $11,600 + $66,000
= $ 77,600

(3) Time and Material Pricing

Time and Material Price = Time Charges + Material Charges
= $11,600 + ($66,000 x 110%)
= $ 84,200
t of materials) x material cost] + Mark-up

t of materials) x material cost] + Mark-up

(12-17) (1) Analysis of Special Order
Revenues $ 75
Variable Cost
Direct mateirals $ 35
Direct manufacturing labor 10
Variable manufacturing overhead 6
Other variable costs 5 56
Contribution Margin $ 19
Number of Units 3,000
Total contribution margin $ 57,000
Less: Sales Commission 8,000
Increase (Decrease) in Operating Income $ 49,000

(2) Pricing Considerations

Total Cost ($14.2M + $5M) $ 19,200,000
Number of units 200,000
Full cost per unit $ 96

On a short-run, yes, because it will increase operating income by $49,000.

On a long-run, it would depend.
No, if there is no longer excess capacity. San Carlos should include other costs such as opportunity cost.
No, if other customers will likely request for price concessions and hurt the current selling price structure.
Yes, if this will start a profitable relationship with Abrams, and Abrams can be a potential long-term customer.

(12-18) (1) Minimum Selling Price (with excess capacity)

Variable Cost ($16 + 5 + 4) $ 25

(2) Minimum Selling Price (without excess capacity)

Variable Cost ($16 + 5 + 4) $ 25
Opportunity Cost 20
Minimum Selling Price $ 45

Lost Contribution Margin (CM) per unit $ 10

Number of units sacrificed (2,600 x 2) 5,200
Total Lost CM $ 52,000
Number of units to be sold 2,600
Opportunity Cost per unit $ 20
rm customer.