Question

Montana Fishing Equipment Company (MFEC) manufactures a variety of fly-fishing equipment, including fly-fishing rods and reels. The company would like to develop a unified approach to pricing its product line for next year using cost-plus pricing but does not know what cost base should be used.

          Last year, MFEC earned $140,000 of profit from sales of its products and would like to earn $200,000 next year. Last year, the company incurred the following costs

       Manufacturing Costs

                                   Variable     $250,000

                                   Fixed     $150,000

                       Selling and Administrative Costs

                                   Variable     $100,000

                                   Fixed     $200,000

Required

A. Calculate the markup percentage for each of the following cost bases:

a. Full costs, including all manufacturing and selling and administrative costs

b. Cost of goods sold

c. Total variable costs

d. Variable manufacturing costs

B. Explain why the markup percentage calculated in question A is lower when using full costs as the base than when using variable manufacturing costs as the base.

C. MFEC’s best fly rod (the Trout Catcher model) costs $150 to manufacture and includes $90 of variable manufacturing costs and $60 of fixed overhead costs. Assuming the company uses a markup on variable manufacturing costs (calculated from A.d.), what is the recommended sales price of the rod?

Competitors sell comparable fly rods for $299. Based on this information, should MFEC price the Trout Catcher model by using a cost-plus approach of a

Answer 1

A.        1.         The markup percentage on full costs is:  $200,000 / $700,000 = 28.57%

2.         The markup percentage on cost of goods sold is: $500,000 / $400,000 = 125%

3.         The markup percentage on total variable costs is: $550,000 / $350,000 = 157.14%

4.         The markup percentage on variable manufacturing costs is: $650,000 / $250,000 = 260%

B.        The markup percentage is lower when using full costs as the base cost because the markup must be sufficient to cover just the expected profit of $200,000. All other costs are included in the cost base. However, when variable manufacturing costs are used as the cost base, the markup must cover fixed manufacturing costs, all selling and administrative costs and an expected profit.

C.        Based on the markup percentage on variable costs calculated in requirement A of 260 percent, the Trout Catcher model will be priced at $324 ($90 variable cost + markup of $234).           

D.        If competitors are selling similar rods for $299, MFEC may need to reduce the price of the Trout Catcher accordingly. Matching the competitor’s price will still provide MFEC with a markup on variable costs of 232 percent.