C. ROI Pricing- practically has the same formula as target cost except that this time total costs are given which you should add to the desired profit base on ROI to arrive at the Target Selling Price.

Desired profit + total costs= Target selling price

Illustration IV: The following information are given to you by Toys R Us and you are required to make a cost analysis and determine the target selling price given that investment cost for the Toy Pickup Truck is P300,000 with an ROI of 30% and an estimated sales volume of 5,000.

	Per Unit	Total
Direct materials is P19.50 Material handling cost of .3 based on purchase price. Advertising cost of P10,000 Direct Labor required is .5 hours per product, hourly rate of P10 Heat, Light and Power (P5,000 fixed rate plus P15 per machine hour) Required machine hours is one hour for every 10 units of products or a total of 500 hours Variable marketing is P4 per product Operating supplies is P2.50 per product Fixed marketing cost is P25,000 Fixed administrative cost is P50,00	19.50 ? ? 5.00 ? ? ? ? ? ?	97,500 ? 5,000 ??
TOTAL	P???	P ???

Desired profit + total unit cost= Target Selling price

?? + = ??

1. If the prices of the competitors range from P75 to P80, is the selling price of Toys R Us lower?
2. If the company prices it at P70 to capture a larger market, desired profit will go down. President says, As long as ROI does not fall below 20%, then we go for a price of P70.

What is the revised ROI?

To arrive at revised ROI, reverse your formula:

Desired profit per unit (lower now if you want to lower selling price) x sales volume=Total desired profit/ investment capital x 100= revised ROI in percent.

C. Traditional pricing method is Cost-Plus Pricing method.

1. In a noncompetitive environment, the company is faced with the task of setting its own price, which is commonly a function of the cost of the product.

2. The typical approach is to use cost-plus pricing which involves establishing a cost base and adding to this cost base a markup to determine a target selling price.

3. The cost-plus pricing approachs major advantage is that it is simple to compute. However, it does not give consideration to the demand side. In addition, sales volume plays a large role in determining per unit costs which in turn affects selling price.

4. The lower the sales volume, the higher the selling price the company must charge to meet its desired ROI. This occurs because fixed costs are spread over fewer units and the fixed cost per unit increases. To compensate, the selling price must be higher in order to meet the desired ROI. For example if total fixed costs of the company is P500,000 and it can produce only 10,000 units, then unit fixed cost per product is P50. If it can produce more say 20,000 units, the unit fixed cost decreases to P25 per unit.

Illustration V: The different methods used under cost plus pricing. Again, remember variable cost is expressed per unit but fixed cost is in total amount so we should per unit it also by determining the capacity level. Let us assume a capacity level of 72,000 units.

Direct Materials			P18
Direct Labor			10
Variable Manufacturing Overhead			5
Variable Selling and Administrative Expenses			3
Fixed Manufacturing Overhead (P180,000/72,000 )			2.50
Fixed Selling and Administrative (P108,000/72,000)			1.50
Total cost per unit			P40
Assume a Mark up rate of 50%
Base mark up on the following:		Compute for markup first then + total cost=SP
a) Full cost pricing(markup based on all cost = P40)		50% x 40 = P20 + total cost P40=P60.00
b) Prime Cost pricing (DM 18 + DL 10 = P28)		50% x P28= P14 + total cost P40= P54.00
c) Conversion cost pricing (DL + VOH + FOH= P17.50)		50% x 17.5 =P8.75+ total cost P40= P48.75
d) Variable cost pricing (DM+DL+VOH+VSA= P36)		50% x P36= P18 + total cost P40= P58.00
e) ROI Pricing: Desire profit based on investment plus total cost		Desired profit P10 * + total cost P40= P50.00

*Desired return on investment should be given to be able to use this method: Assume an ROI of 50%

Investment P1,000,000 x 50% desired profit= P500,000/ sales volume 50,000 = desired profit of P10

4. Using the following data, compute for the selling price under 5 approaches

With the different cost data and selling prices, management has many ways of using and treating these vis--vis competitors prices and customers reactions. Note that you can go as low as P50 selling price without making the stockholders or investors unhappy since you complied with the rate of return. Of course if it is still possible to increase the selling price then the company will do it. Just be careful of the reaction of the competitors and customers. Again, it depends on the classification of your product given the different market conditions which was described in the first page.

5. No company operates in a vacuum. It must be aware of a) the actions of competitors. b) products of competitors, c) market forces and conditions that can affect demand and force the company to lower price 6. What is the market condition? a. In a monopoly there is no direct competitor, you can name your price which is 1. Do It!!! Give 2 examples of products regulated only by the government. under each market b. In a monopolistic competition, there are many sellers but no one has a direct condition influence in the market. So the prices must not be so far apart. There are many sellers of similar but not identical products. c. In an oligopoly there are large sellers that dominate the market and basically compete with one another. Here is where competition is stiff they should be able to convince customers to choose their product vis a vis quality, uniqueness of product or service or additional promotion d. In a perfectly competitive market, the goods are homogenous, neither the buyer or seller can individually influence the price by their action. Law of supply and demand prevails. Since objective is not only recovery of cost but achievement of desired profit, the formula is : Cost + Desired Mark Up = selling price Normally the desired mark up or profit is based on ROI or return on investment. Remember this in Financial Statement Analysis Module