Zach Automobiles Ltd manufactures and sells two models of car, Yen-Oh-1000, an economy car, and Zen-Fi, a luxury car. Yen-Oh-1000 is a five-door hatchback with front-wheel drive. Zach Automobiles Ltd had made an initial investment of £2,500,000,000 towards the manufacture and sale of these cars. The costs incurred to manufacture and sell Yen-Oh-1000 are given below:

Zen-Fi is a two-door sports car with all-wheel drive and a 6.2 litre V12 engine. Zach Automobiles Ltd had made an initial investment of £100,000,000 towards the manufacture and sale of these sports cars. The costs incurred to manufacture and sell Zen-Fi are given below:

Management is planning to reduce the selling price of both cars by 10%. According to market research, a decrease in the selling price of 10% will increase the demand for Yen-Oh-1000 by 25% and will increase the demand for Zen-Fi by 18%. The selling price of one Yen-Oh-1000 is £21,000 and of one Zen-Fi is £200,000. The total variable cost to manufacture one Yen-Oh-1000 is £11,000 and to manufacture one Zen-Fi is £70,000. In a year, Zach Automobiles Ltd sells 80,000 units of Yen-Oh-1000 and 20,000 units of Zen-Fi.

Required

1. Calculate the profit-maximizing mark-up on the variable cost for Yen-Oh-1000 and Zen-Fi.

2. Zach Automobiles decides to set the selling price of Yen-Oh-1000 equal to the profit-maximization mark-up on variable cost. Determine the contribution margin of Yen-Oh-1000. Compare this contribution margin with the contribution margin from the existing selling price.

3. Zach Automobiles decides to set the selling price of Zen-Fi equal to the profit-maximization mark-up on variable cost. Determine the contribution margin of Zen-Fi. Compare this contribution margin with the contribution margin from the existing selling price.

4. Zach Automobiles decides to set the target selling price of its cars using the absorption costing approach to cost-plus pricing. Determine the target selling price of one Yen-Oh-1000 and one Zen-Fi. The company expects the return on investment to be at least 15% from both car segments.

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Direct material Direct labour Variable overhead Fixed overhead Variable selling, general and administrative costs Fixed selling, general and administrative costs Per car £5,000 3,500 1,500 £1,000 Total £280,000,000 £268,000,000