P7–9 Pricing Time allowed: 30 minutes A small company is engaged in the production of plastic tools for the garden.

Subtotals on the spreadsheet of budgeted overheads for a year reveal:

For the purposes of reallocation of general factory overhead it is agreed that the variable overheads accrue in line with the machine hours worked in each department.
General factory fixed overhead is to be reallocated on the basis of the practical machine hour capacity of the two departments.
It has been a long-standing company practice to establish selling prices by applying a mark-up on full manufacturing cost of between 25 and 35%.
A possible price is sought for one new product which is in a final development stage. The total market for this product is estimated at 200,000 units per annum. Market research indicates that the company could expect to obtain and hold about 10% of the market. It is hoped the product will offer some improvement over competitors’ products, which are currently marketed at between £90 and £100 each.
The product development department has determined that the direct material content is £9 per unit. Each unit of the product will take two labour hours (four machine hours) in the moulding department and three labour hours (three machine hours) in finishing. Hourly labour rates are £5.00 and £5.50 respectively.
Management estimate that the annual fixed costs which would be specifically incurred in relation to the product are: supervision £20,000, depreciation of a recently acquired machine £120,000 and advertising £27,000. It may be assumed that these costs are included in the budget given above. Given the state of development of this new product, management do not consider it necessary to make revisions to the budgeted activity levels given above, for any possible extra machine hours involved in its manufacture.
Required 1 Briefly explain the role of costs in pricing.
2 Prepare full cost and marginal cost information which may help with the pricing decision.
3 Comment on the cost information and suggest a price range which should be considered.

Transcribed Image Text:

Moulding Department Finishing Department General factory Overhead Variable overhead (2000) 1,600 500 1,050 Fixed overhead (2000) 2,500 850 1,750 Budgeted activity Machine hours (000) 800 600 Practical capacity Machine hours (000) 1,200 800