Valmont Company has developed a new industrial piece of equipment called the XP-200. The company is considering two methods of establishing a selling price for the XP-200-absorption cost-plus pricing and value-based pricing.
Valmont's cost accounting system reports an absorption unit product cost for XP-200 of $8,400. Its markup percentage on absorption cost is 85%. The company's marketing managers have expressed concerns about the use of absorption cost-plus pricing because it seems to overlook the fact that the XP-200 offers superior performance relative to the comparable piece of equipment sold by Valmont's primary competitor. More specifically, the XP-200 can be used for 20,000 hours before replacement. It only requires $1,000 of preventive maintenance during its useful life and it consumes $120 of electricity per 1,000 hours used.
These figures compare favorably to the competing piece of equipment that sells for $15,000, needs to be replaced after 10,000 hours of use, requires $2,000 of preventive maintenance during its useful life and consumes $140 of electricity per 1,000 hours used.
Required:
1. If Valmont uses absorption cost-plus pricing, what price will it establish for the XP-200?
2. What is XP-200's economic value to the customer (EVC) over its 20,000-hour life?
3. If Valmont uses value-based pricing, what range of possible prices should it consider when setting a price for the XP-200?
4. What advice would you give Valmont's managers when choosing between absorption cost plus pricing and value-based pricing?