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Hilton CH 15 Select Solutions
Hilton CH 15 Select Solutions
15.9 Three limitations of the economic, profit-maximizing model of pricing are as follows:
(1) The firm’s demand and marginal revenue curves are difficult to determine with
precision.
(2) The marginal-cost, marginal-revenue paradigm, as described in the text, is not valid
for all forms of market organization.
(3) Cost-accounting systems are not designed to measure the marginal changes in cost
incurred as production and sales increase unit by unit. To measure marginal cost
would entail a very costly information system.
15.10 Determining the best approach to pricing requires a cost-benefit trade-off. While the
marginal-cost, marginal-revenue paradigm results in a profit-maximizing price, only a
sophisticated and costly information system can collect marginal-cost data. Thus, the
firm will incur greater cost in order to obtain information for better decisions.
15.13 Four reasons often cited for the widespread use of absorption cost as the cost base in
cost-plus pricing formulas are as follows:
(1) In the long run, the price must cover all costs and a normal profit margin.
(2) Absorption-cost and total-cost pricing formulas provide a justifiable price that tends
to be perceived as equitable by all parties.
(3) When a company’s competitors have similar operations and cost structures, cost-
plus pricing based on full costs gives management an idea of how competitors may
set prices.
(4) Absorption-cost information is provided by a firm’s cost-accounting system, because
it is required for external financial reporting under generally accepted accounting
principles. Since absorption-cost information already exists, it is cost-effective to use
for pricing.
PROBLEM 15-38 (45 MINUTES)
1. The order will boost Heartland’s net income by $13,950, as the following calculations
show.
Sales revenue ...................................................... $82,500
Less: Sales commissions (10%)........................... 8,250 $74,250
Less manufacturing costs:
Direct material................................................. $14,600
Direct labor 28,000
Variable manufacturing overhead*................................. 8,400
Total manufacturing costs 51,000
Income before taxes............................................. $ 23,250
Income taxes (40%).............................................. 9,300
Net income ...................................................... $ 13,950
*Based on an analysis of the year just ended, variable overhead is 30 percent of direct
labor ($1,125 ¸ $3,750). For Premier’s Foods’ order:
Direct-labor cost x .30 = $28,000 x .30 = $8,400.
2. Yes. Although this amount is below the $82,500 full-cost price, the order is still
profitable. Heartland can afford to pick up some additional business, because the
company is operating at 75 percent of practical capacity.
Sales revenue ............................................................ $63,500
Less: Sales commissions (10%)................................. 6,350 $57,150
Less manufacturing costs:
Direct material....................................................... $14,600
Direct labor 28,000
Variable manufacturing overhead......................... 8,400
Total manufacturing costs…………………… 51,000
Income before taxes................................................... $ 6,150
Income taxes (40%).................................................... 2,460
Net income ............................................................ $ 3,690
Note that the fixed manufacturing overhead and fixed corporate administration costs are
not relevant in this decision, because these amounts will remain the same regardless of
what Heartland’s management decides about the order.
PROBLEM 15-38 (CONTINUED)
$135,000
= $20.00 + 12,000
+ $5.00
3. Price of job without markup on material costs (from requirement 2) ............. $ 97,000
Markup on total material costs ($82,500 10%) .......................................... 8,250
Total price of job ........................................................................................... $105,250
$16,000
= 1,000,000
= $.016
2. As in requirement (1), 500 direct-labor hours are required for the job.
3. Under the supposition that the price computed by Manhattan Pharmaceuticals, Inc.
using Wyant’s criterion is greater than $0.03, the factors that Manhattan’s management
should consider before deciding whether or not to submit a bid at the maximum
allowable price include whether Manhattan Pharmaceuticals has excess capacity,
whether there are available jobs on which earnings might be greater, and whether the
maximum bid of $0.03 contributes toward covering fixed costs.
1. The minimum price per blanket that Detroit Synthetic Fibers, Inc. could bid without
reducing the company’s net income is $48 calculated as follows:
2. Using the full cost criteria and the maximum allowable return specified, Detroit Synthetic
Fibers, Inc.’s bid price per blanket would be $59.80 calculated as follows:
3. Factors that management should consider before deciding whether to submit a bid at
the maximum acceptable price of $50 per blanket include the following:
The company should be sure there is sufficient excess capacity to fill the order and
that no additional investment is necessary in facilities or equipment that would
increase fixed costs.
If the order is accepted at $50 per blanket, there will be a $2 contribution per blanket
to cover fixed costs. However, the company should consider whether there are other
jobs that would make a greater contribution.
Acceptance of the order at a low price could cause problems with current customers
who might demand a similar pricing arrangement.
PROBLEM 15-44 (25 MINUTES)
1. Target costing is more appropriate. MSC is limited in terms of what price it can
charge due to market conditions. A cost-plus-markup approach will use the desired
markup for the company; however, the resulting price may too high and not
competitive. In such an environment it makes more sense to use target costing, which
begins with the price to be charged and works backward to determine the allowable
cost.
Since total revenue must equal $6,915,000, the revenue per hour must be $276.60
($6,915,000 ÷ 25,000 hours).
No. A 14% return requires that MSC generate revenue per service hour of $298.20
($7,455,000 ÷ 25,000 hours), which is clearly in excess of the $265 market price.
5. To achieve a 14% return and a $265 revenue-per-hour figure, the company must trim
its costs. MSC could use value engineering, a technique that utilizes information
collected about a service’s design and associated production process. The goal is to
examine the design and process and then identify improvements that would produce
cost savings.
Department I Department II
Variable overhead
Department I: 37,500 $12 .......................................................................
$450,000
Department II: 37,500 $6 ......................................................................... $ 225,000
Fixed overhead .............................................................................................
225,000 225,000
Total overhead .............................................................................................
$675,000 $ 450,000
Total budgeted overhead for both
departments ($675,000 + $450,000) ........................................................... $1,125,000
Total expected direct-labor hours for
both departments (37,500 + 37,500) ........................................................... 75,000
budgeted overhead
Predetermined overhead rate = budgeted direct -labor hours
$1,125,000
= 75,000
2. Standard Deluxe
Total cost ......................................................................................................
$600.00 $750.00
Markup (15% of cost)
Standard: $600 .15 .................................................................................
90.00
Deluxe: $750 .15 ......................................................................................
______ 112.50
Price .............................................................................................................
$690.00 $862.50
3. Department I Department II
Budgeted overhead (from requirement 1)......................................................
$675,000 $450,000
Budgeted direct-labor hours .........................................................................
37,500 37,500
$675,000 $450,000
Calculation of predetermined overhead rate .................................................
37,500 37,500
4. Standard Deluxe
Direct material ..............................................................................................
$240 $390
Direct labor ...................................................................................................
210 210
Manufacturing overhead:
Department I:
Standard: 2 $18 ......................................................................................
36
Deluxe: 8 $18 .......................................................................................... 144
Department II:
Standard: 8 $12 ......................................................................................
96
Deluxe: 2 $12 ..........................................................................................
24
Total cost ......................................................................................................
$582 $768
5. Standard Deluxe
Total cost (from requirement 4).....................................................................$582.00 $768.00
Markup (15% of cost)
Standard: $582 .15 ..................................................................................87.30
Deluxe: $768 .15 ......................................................................................
______ 115.20
Price .............................................................................................................
$669.30 $883.20
6. The management of Super Sounds, Inc. should use departmental overhead rates. The
overhead cost structures in the two production departments are quite different, and
departmental rates more accurately assign overhead costs to products. When the
company used a plantwide overhead rate, the Standard speakers were overcosted and
the Deluxe speakers were undercosted. This in turn resulted in the Standard model being
overpriced and the Deluxe model being underpriced. The cost and price distortion
resulted from the following facts: (1) the Standard speakers spend most of their
production time in Department II, which is the least costly of the two departments; and (2)
the Deluxe speakers spend most of their production time in Department I, which is more
costly than Department II.
PROBLEM 15-47 (35 MINUTES)
1. Target costing is market driven, beginning with a determination of the selling price
that customers are willing to pay. That price is dependent on the product they
purchase and the product’s features. It is only natural that a marketing team becomes
heavily involved in this process, since customer feedback is crucial to the design
process.
2. Add cabinet doors: [(10 x 1) + (20 x 2) + (30 x 3) + (60 x 4) + (80 x 5)] = 780; 780 ÷
200 = 3.900
Expand storage area: [(10 x 1) + (40 x 2) + (70 x 3) + (50 x 4) + (30 x 5)] = 650; 650 ÷
200 = 3.250
Add security lock: [(30 x 1) + (60 x 2) + (50 x 3) + (40 x 4) + (20 x 5)] = 560; 560 ÷
200 = 2.800
New appearance for table top: [(10 x 1) + (20 x 2) + (50 x 3) + (60 x 4) + (60 x 5)] =
740; 740 ÷ 200 = 3.700
Extend warranty: [(40 x 1) + (70 x 2) + (30 x 3) + (35 x 4) + (25 x 5)] = 535; 535 ÷
200 = 2.675
PROBLEM 15-47 (CONTINUED)
3. (a) Danish Interiors currently earns a $48 profit on each table sold ($240 - $192),
which translates into a 20% markup on sales ($48 ÷ $240). The current
competitive market price is $285, which means that if the company maintains
the 20% markup, it will earn $57 ($285 x 20%) per unit. The maximum
allowable cost is therefore $228 ($285 - $57).
(b) Customers feel most strongly about adding cabinet doors and giving the table
top a new appearance. Both of these features can be added, and Danish
Interiors will be able to earn its 20% markup. The third and fifth most
desirable features (the expanded storage area and extended warranty) are too
costly. If it desires, management could also add a lock to the storage area.
Supporting calculations follow.
4. An expanded storage area would be the most logical additional feature in view of its
no. 3 ranking. Danish Interiors might use value engineering to study the design and
production process of both the table as currently manufactured as well as the proposed
new features. The goal is to identify improvements and associated reductions in cost
that may allow the company to add previously rejected options.