Question

ALG Co. is launching a new, innovative product onto the market and is trying to decide on the
right launch price for the product. The product’s expected life is three years. Given the high level
of cost which have been incurred in developing the product, ALG Co. wants to ensure that it sets
its price at the right and has therefore consulted a market research company to help it do this. The
research, which relates to similar but not identical product launch by other companies, has reveal
that at a price of Ghc 60, annual demand would be expected to be 250,000 units. However, for
every Ghc 2 increase in selling price, demand would be expected to fall by 2,000 units and for
every Ghc 2 decrease in selling price, demand would be expected to increase by 2,000 units.
A forecast of the annual production cost which would be incurred by ALG Co in relation to the
new product are as follows:
Annual production (units) 200,000 250,000 300,000 350,000
Ghc Ghc Ghc Ghc
Direct material 2,400,000 3,000,000 3,600,000 4,200,000
Direct labour 1,200,000 1,500,000 1,800,000 2,100,000
Overheads 1,400,000 1,550,000 1,700,000 1,850,000

Required:
a. Calculate the total variable cost per unit and total fixed overheads.

b. Calculate the optimum (profit maximizing) selling price for the new product and
calculate the resulting profit for the period.
Note: P = a – bx then MR = a – 2bx

The sales director is unconvinced that the sales price calculated in (b) above is the right one to
charge on the initial launch of the product. He believes that a price should be charged at the launch
so that those customers prepared to pay a higher price for the product can be skimmed off first.

Required:
Discuss the conditions which would make market skimming a more suitable pricing strategy for
ALG Co. and recommend whether ALG Co. should adopt this approach.

Just this part of the question is required with detailed explanation :

Required:
Discuss the conditions which would make market skimming a more suitable pricing strategy for
ALG Co. and recommend whether ALG Co. should adopt this approach.

Answer 1