ABDT5104 PRICING STRATEGY Tutorial 3 Answer June 7, 2011

Question 1
The incremental variable cost for a change in sales is often not equal to the average variable cost.

Example overtime vs. average cost production.

Company A

Production: 1,100 units

Material cost: RM4, 400

8, 00 (regular pay)
Labor Cost: RM9, 200
1,200 (overtime)

Option 1: Determine pricing based on average variable cost:

4,400+9,200
=RM 12.36/unit → Underpricing if demand increase.
1,100

Option 2: Determine pricing based on incremental variable cost:

4,400
Material costs = =RM 4 /unit
1,100
Assume employee can produce 100
1,200
Labor costs = =RM 12/unit units during overtime hour
100
RM16

Hence, the result above show that, average variable cost is not equal with incremental variable
cost.

Question 2
i. AB
ii. A
iii. C
iv. A=C
v. (P1-P2)*Q
= (2-1.8)*1,000
= $200
vi. A=C=$200
vii. (P2-vc)*Q=200
= (1.8-0.5)*Q=200
Q= 1,154 unit
viii. The price cut will be profitable only if it results in an increase in monthly sales volume of
more than 15.38%. the company must now sell at least 1,154 units to maintain the same
level of profitability it had achieved before the price reduction.
ABDT5104 PRICING STRATEGY Tutorial 3 Answer June 7, 2011
ABDT5104 PRICING STRATEGY Tutorial 3 Answer June 7, 2011

Question 3
Three steps for financial analysis pricing are:

1. Determine the contribution margin. This is the foundation for all pricing financial analysis
calculations.
2. Calculate the break-even sales change for the price change. Given a price change, this is the
change in sales volume require to breakeven, thus defining the point at which a price
change becomes either profitable or unprofitable.
3. Calculate the profit implication of sales changes greater or less than the break-even sales
change. Having defined the boundary of price change profitability, what are the profit
implications of actual sales changes that are greater than the breakeven sales change
calculation in step 2. That is, given a price change, if the change in sales were greater than
the breakeven sales change how much addition profit would the firm realize from the price
change.

Question 4
CM=40-16
=24
−(−6)
%breakeven sales change = =33.33%
24+(−6)
Units BE sale change= 0.333* 20,000 = 6,666 units
∴20, 000 + 6, 660 = 26,666 units.
i. The price cut will only be profitable if it results in an increase in weekly sales volume at
more than 33.33%. The company must sell at least 26,666 units to maintain the same level
of profitability they have achieved before price reduction otherwise it is best for the
company to hold on to $40.

−(6)
%breakeven sales change = =-20%
24+(6)
Units BE sale change= -0.20 * 20,000 = -4,000 units
∴20, 000 - 4, 000 = 16,000 units.
ii. The price increase will only be profitable only if it result in an reduction in weekly sales
volume at less than 20%. The company must sell at least 16, 000 units to maintain the same
level of profitability they have achieve before price increase, otherwise it is best for the
company to hold on $40.