Pricing decision and the calculation of expected profit and margin of safety E Ltd manufactures a hedge-trimming device which has been sold at 16 per unit for a number of years. The selling price is to be reviewed and the following information is available on costs and likely demand. The standard variable cost of manufacture is 10 per unit and an analysis of the cost variances for the past 20 months show the following pattern which the production manager expects to continue in the future. Adverse variances of +10% of standard vari- able cost occurred in ten of the months. Nil variances occurred in six of the months. Favourable variances of -5% of standard vari- able cost occurred in four of the months. Monthly data Fixed costs have been 4 per unit on an average sales level of 20000 units but these costs are expected to rise in the future and the following estimates have been made for the total fixed cost:

It can be assumed that all estimates and probabil- ities are independent. You are required to

(a) advise management, based only on the infor- mation given above, whether they should alter the selling price and, if so, the price you would recommend; (6 marks)

(b) calculate the expected profit at the price you recommend and the resulting margin of safety, expressed as a percentage of expected sales; (6 marks)

(c) criticise the method of analysis you have used to deal with the probabilities given in the question; (4 marks)

(d) describe briefly how computer assistance might improve the analysis. (4 marks) (Total 20 marks) CIMA

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Optimistic estimate (Probability 0.3) Most likely estimate (Probability 0.5) Pessimistic estimate (Probability 0.2) () 82 000 85 000 90000 The demand estimates at the two new selling prices being considered are as follows: If the selling price/unit is 17 18 demand would be: Optimistic estimate 21000 units 19000 units (Probability 0.2) Most likely estimate 19000 units 17500 units (Probability 0.5) Pessimistic estimate 16500 units 15 500 units (Probability 0.3)