Learn About Pricing Strategies, Relevant Costing, And Investments

Option a) i: True and ii: False

Option a) i: True and ii: False

Opportunity cost is best explained as the next best alternative and refers to the any loss of gain or opportunity which could have been gained otherwise if some other alternative would have been selected.

In the event of a decline in demand of the product, the manufacturer must consider decreasing the mark-up value of the product as a reduction in price can help restore demand. An increase in mark-up will increase the price even further which will even affect the demand further thus affecting sales and profitability.

Penetration pricing and price skimming are two different types of pricing strategies. The penetrating pricing strategy is used by businesses to lure customers initially by pricing the products low and eventually raising prices once building a customer base and an increase in the market share. The price skimming strategy is the exact polar opposite wherein prices are initially set high and are then lowered gradually to attract customers.

The suggestion is wrong. This is because if production is below the break even output, the business will generate an operating loss. It is only if the business produces and sells above the break even units will the business generate profits.

1. a) Sometimes True.

The three areas wherein relevant costing may be applied by the business are outlined as follows:

1. Buying or Selling decisions.
2. Special order decisions.
3. In keeping a business unit or stopping production activities.

Period Costs.

Avoidable costs are best explained as costs which can totally be eliminated if the business does not engage in performing an activity. The example of such costs are variable costs. On the contrary, irrelevant costs are those costs which does not get affected by decisions that are made by the management. An example of such a costs is fixed overhead such as sunk costs.

True.

Any four qualitative factors that have to be considered in the case of make or buy decisions have been listed as follows:

1. Reliability and Reputation of the third party/suppliers.
2. Long term outlook concerning production.
3. Likelihood of reversing decisions in future.
4. Quality of product or service being provided when compared to benchmarks.

Notional Costs

The two techniques that are used in total productive maintenance approach are identified as follows:

1. Method Approach
2. Implementation Approach

The three non-financial performance measures for measuring resource utilization have been mentioned as follows:

1. Customer Perspective: Conversion Rate.
2. Internal Business Perspective: Production Efficiency.
3. Learning and Growth Perspective: Employee Productivity Rate.

The term ‘internal rate of return’ is best explained as the discount rate at which the npv of the investment is zero. This indicates the total relative returns which an investment will generate therefore gauging the relative profitability of an investment. If the calculated irr is higher than the weighted average cost of capital, the npv will be positive rendering the investment to be favorable.

Payback Period for North = 3 + (50000/120000) = 3.42 years

Payback Period for Southeast = 3 + (100000/100000) = 3 years

The payback period of an investment is the total time within which the investment is able to recover the initial outlays. The calculated payback of Southeast project at 3 years is much favorable when compared to 3.42 years of North project. However, the npv of the investment is the absolute returns an investment can generate which results in maximizing the wealth of the company and therefore in turn the wealth of shareholders. The NPV of North project is higher at £21,875 when compared to £ 15,266 of Southeast Project. Since the investment opportunity is mutually exclusive which means Jefferson Ltd can only select one investment, they should consider the North project for it will bring in more value to company.

Opportunity cost and pricing strategies

 It is to be noted that the company should not take this option. This is because the total contribution of the business originally was £4,520 (2,520 + 2,000) while in this option the total contribution worth £45575 (2551+2024) is subject to a fixed cost of 250 which is not the case originally resulting in profits the be lower. Hence, the option must not be accepted.

Standard Labour Rate: 31500/3937.5 = £8, Actual Labour Rate: 31950/3900 = £8.2

Standard Material Price: 63000/63000 = £1, Actual Material Price: 61800/60750 = £1.02

Budgeted Sales Price: 157500/5000 = £31.5, Actual Sales Price: 156450/5000 = £31.29

(i) Labour rate variance = (Standard Rate*Actual Hours) – (Actual Rate*Actual Hours) = (8*3900) – (8.2*3900) = £750 A

(ii) Labour efficiency variance = (Standard Hours – Actual Hours) * Standard Rate = (3937.5 – 3,900) * 8 = £300 F

(iii) Material price variance = (Standard Price – Actual Price) *Actual Quantity = (1-1.02) *60750 = £1050 A

(iv) Material usage variance = (Standard Quantity – Actual Quantity) *Standard Price = (63000-60750)*1 = £2250 F

(v) Fixed overhead variance = (Actual output x fixed costs overhead absorption rate)- Actual fixed cost = (5000*30000/5000) – 29100 = 900 F

(vi) Sales price variance = (Actual Price – Budgeted Price) x Actual Quantity = (31.29-31.5) * 5000 = 1050 A

(i) Labour rate variance: This variance helps to understand the difference between the expected and actual cost of labour. As seen above, the variance is adverse because the actual rate of labour turned out to be higher than the standard rate. This variance may have been caused because of labour union issues, payment of overtime & shift premiums, production downtime and incorrect standard setting.

(ii) Labour efficiency variance: This variance aims to understand the difference between the total labour hours actual used in production and the total estimated hours. Turns out, this variance is favorable as the total actual hours used was less than what was budgeted for. Some of the reasons for such variances are possibility of skilled labour, improvement in production methodologies and training of workforce.

(iii) Material price variance: This variance aims to gauge the difference in the prices in which materials are expected to be purchases and the actual price at which these are purchased. The variance in this case turns out to be adverse because of a higher rate than the budgeted rate. This is possibly because of changes in pricing, inflation, an increase in the bargaining power of suppliers and rush deliveries.

(iv) Material usage variance: The material usage variance is the variance caused because of the difference between the total materials actually used in the production process and the budgeted material usage. This variance is favourable as the actual kgs of materials used for producing 5000 units of products turned out lower than what was expected. An improvement in these variances is possible because of an efficiency in the production process based on optimal utilization of resources.

(v) Fixed overhead variance: The fixed overhead cost variance is the difference in between the absorbed fixed costs and the actual fixed cost which is incurred. The variance has been calculated to be favourable as the actual overheads incurred were less than the absorbed fixed overheads.

(vi) Sales price variance: The sales price variance as the name suggests is the variance caused because of the difference in between the expected selling price per unit and the price at which the product is actually sold. This variance is adverse because the business could not sell its products at the price it intended to sell it in.

The cost plus pricing strategy is also referred to as the markup pricing strategy and is quite a simple technique of pricing where the price at which the product/service will be sold/provided to the customers is determined by adding a fixed percentage (also known as the mark-up) on the total cost. Some of the noteworthy limitations of this pricing strategy have been outlined as follows:

1. The pricing strategy tends to ignore competition as peers may be charging prices that are substantially different for the same goods and services. This will have a toll on the market share and profits of the company.
2. Product costs overruns is another potential limitation that is associated with the strategy. This is because using this pricing technique, the design team or the production team will have no incentives to design or produce with prudence resulting in higher costs.
3. This method of pricing also ignores replacement costs as these are based on historical costs that may have been changed subsequently.
4. Lastly, another important limitation of the method is that customers do not equate the actual costs to value. If a costly product has less perceived value, there may be reluctancy on the part of customers to purchase. This strategy therefore does not consider the expectations of the intended target market into pricing the final product or service.

Target Price per Unit: £20 per unit

Expected return on sales target: 25%

Therefore, returns = 20*25% = £5 per unit.

Target cost per unit = 20-5 = £15 per unit

Estimated annual sales target volume = 50000

Target Price = £20 per unit

Total Sales Target = 50000 * 20 = £1000000

Estimated Returns = £1000000 * 25% = £250000

Target Costs = £1000000 – £250000 = £750000

Target Cost per unit = 750000/50000 = £15 per unit.

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