Advanced : Selling price decision based on expected values and value of additi onal i nformation Warren Ltd is to produce a new product in a short-term venture which will utilize some obsolete materials and expected spare capacity. The new product will be advertised in quarter I with production and sales taking price in quarter II. No further produchon or sales are anticipated.

Sales volumes are uncertain but will, to some extent. be a function of sales price. The possible sales volumes and the advertising costs associated with each potential sales price are as follows:

The resources used in the production of each unit of the product are:

However, before considering the effects of the current venture, there is expected to be 4000 hours of idle time for each grade of labour in quarter II. Idle time is paid at the normal rates.
Material X is in stock at a book value of £8 per unit, but is widely used within the firm and any usage for the purposes of this venture will require replacing. Replacement cost is £9 per unit.
Material Y is obsolete stock. There are 16 000 units in stock at a book value of £3.50 per unit and any stock not used will have to be disposed of at a cost, to Warren, of £2 per unit. Further quantities of Y can be purchased for £4 per unit.
Overhead recovery rates are Variable overhead £2 per direct labour hour worked Rxed overhead £3 per direct labour hour worked Total fixed overheads will not alter as a result of the current venture.
Feedback from advertising will enable the exact demand to be determined at the end of quarter I and production in quarter II will be set to equal that demand. However, it is necessary to decide now on the sales price in order that it can be incorporated into the advertising campaign.
Required:

(a) Calculate the expected money value of the venture at each sales price and on the basis of this advise Warren of its best course of action. (12 marks)

(b) Briefly explain why the management of Warren m1ght rationally reject the sales price leading to the highest expected money value and prefer one of the other sales prices. (4 marks)

(c) It will be possible, for the sales price of £40 per unit only, to ascertain which of the four levels of demand will eventuate.
If the indications are that the demand will be low then the advertising campaign can be cancelled at a cost of £10 000 but it would then not be possible to continue the venture at another sales price. This accurate information concerning demand will cost £5000 to obtain.

Indicate whether it is worthwhile obtaining the information and ascertain whether it would alter the advice given in (a}
above.

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Sales price 20 per unit Sales price 25 per unit Sales price 40 per unit Sales Sales Sales volume volume volume units units units (000) Probability (000) Probability (000) Probability 468 0.1 2 0.1 0 0.2 6 0.4 5 0.2 3 0.5 8 0.5 6 0.2 10 0.2 8 0.5 15 0.1 Advertising costs 20000 50000 100 000