Question 6 (7 marks)

1. You overheard two students' conversation about pricing after a class:

Student 1 - We can drop prices in the short run to cover differential variable and fixed costs. But in the long run, prices must cover all variable and fixed costs.

Student 2 How is that possible? Shouldn't we always cover all our costs, short-term and long-term?

Required:

Write an appropriate response to clarify the pricing concept the students are discussing. (3 marks)

ANSWER a:

1. Almond Delites manufactures various types of biscuits. FMF Biscuits Ltd has approached Almond Delites with a proposal to sell the company its top-selling biscuit at a price of $22 000 for 20 000 units. The costs shown are associated with the production of 20 000 units of almond biscuits:

The manufacturing overhead consists of $2 000 of variable costs, with the balance being allocated to fixed costs. Assume that 40% of the fixed costs would be avoidable if the almond biscuits were purchased externally rather than produced internally.

Required:

1. Should Almond Delites make or buy the almond biscuit? (2 marks)

ANSWER b (i):

1. What qualitative factors should Almond Delites consider before making its decision? (2 marks)

ANSWER b (ii):