Question 2 (20 marks)

Health for All (H4A) is launching a new innovative hand sanitizer. However, due to intense research and development required to meet regulatory requirements, H4A wants to ensure they charge the correct price to recover all these costs.

Through their research they identified that if they charge N$60 per bottle of sanitizer, 250 000 bottles will be demanded per year. They expect that the demand for sanitizers will fall in the next three years therefore they have estimated this product to have a life of 3 years.

Given the current Covid-19 pandemic, many other businesses are also selling hand sanitizers. Therefore the market that H4A wants to enter has a very high elastic demand. It has thus been observed that if H4A increases its price by N$2, the demand will fall by 2 000 bottles while a reduction in price by the same amount will increase demand by 2 000 bottles as well. The production of the sanitizers will incur the following costs per year at differing levels of production.

Annual production (units) 200 000 250 000 300 000 350 000 N$000 N$000 N$000 N$000

Direct materials 2 400 3 000 3 600 4 200 Direct Labour 1 200 1 500 1 800 2 100

Overheads 1 400 1 550 1 700 1 850

Required:

8.1 In determining the correct price to charge, the sales consultant knows that it is imperative to understand cost behavior. Calculate the variable cost of producing a bottle and the total fixed production overheads for H4A per year. 5 5

8.2 What price should be charged per bottle of sanitizer if H4A want to make maximum profits following that P = a bx and MR = a 2bx. What profit will they make?

8.3 The Managing director feels the price you determined in 8.2 is too low. He opines that skimming should be used. Advise him if this is the best approach for H4A. Your answer will be marked correct if it applies to the case of H4A.