Question

In: Accounting

Company Epsilon is considering entering the active marketing advisory service and there has been much discussion...

Company Epsilon is considering entering the active marketing advisory service and there has been much discussion regarding how much a marketing advisor should charge per hour of service. The company has budgeted to supply 500,000 hours of advisory service for the forthcoming year. Its variable cost is estimated at $25 per hour and its fixed costs are estimated at $500,000 for the forthcoming year. The company has been discussing whether to use a cost-plus approach or perhaps examining the demand levels. The marketing department has the following information on demand levels at different prices:

Price per hour

Demand in hours

$27

520,000

$28

500,000

$29

400,000

$30

300,000

$31

225,000

Required:

1. Calculate the price per hour Company Epsilon should charge based on a cost-plus approach for pricing the service at full cost plus 15%.

2. Considering the company can meet any demand level in the table above and that fixed costs will remain unchanged for all the preceding demand levels, what price per hour should the company charge?

3. Explain whether the different approaches lead to a different or identical price per hours and which approach should the company choose for the active marketing advisory service.

Solutions

Expert Solution

Answer to Part 1 :

Budgeted Supply = 5,00,000 hours

Variable cost (VC) per hour = $ 25.

Fixed Costs = $ 5,00,000

Hence, Total Cost or Full Cost = Total Variable Cost + Fixed Costs

i.e. = 5,00,000 * 25 + 5,00,000

i.e. = $ 13,000,000

Hence, Total Service Price based on Cost-plus approach = Full Cost + 15%

i.e. $ 13,000,000 + 15% = $ 14,950,000

Price per hour = $ 14,950,000 / 5,00,000 = $ 29.90 per hour.

Answer to Part 2 :

For determining the optimum price per hour that company should charge, we have to find which price-demand combination from the given table yields highest total contribution. (as fixed cost remains unchanged, it is irrelevant).

Price per hour Variable Cost per hour Contribution per hour
(Price - VC)
Demand in hours Total Contribution
(Contribution per hour * Demand)
$27 $25 $2 520,000 $1,040,000
$28 $25 $3 500,000 $1,500,000
$29 $25 $4 400,000 $1,600,000
$30 $25 $5 300,000 $1,500,000
$31 $25 $6 225,000 $1,350,000

Hence, from the above analysis, it is evident that total contribution is highest at $ 1,600,000 when price is $ 29 per hour. Hence, company should charge $ 29 per hour to get a profit of $ 1,600,000 - $ 5,00,000 = $ 1,100,000.

Answer to Part 3 :

The cost-plus approach and price-demand based approach to service pricing lead to different prices per hour. The price-demand based pricing approach (done in Part 2) should be chosen as it is more practical as it gives consideration to economy theory price-demand relationship. The cost-plus approach tells to sell 5,00,000 hours at $ 29.9 per hour. But to sell 5,00,000 hours, the price needs to be $ 28 per hour as per price-demand relationship. Hence, it is not practical to give effect to cost-plus approach. On the other hand, price-demand approach is more pragmatic and hence advisable.


Related Solutions

"A company is considering entering into a new marketing campaign. If it engages in this marketing...
"A company is considering entering into a new marketing campaign. If it engages in this marketing campaign, it must pay $10,000 immediately and $8,000 each at the end of year 1 and year 2. The company believes its annual revenues due to the marketing campaign will be $12,000 at the end of year 1, $10,000 at the end of year 2, and $7,000 at the end of year 3. What is the annual equivalent worth of this marketing campaign over...
economics question "A company is considering entering into a new marketing campaign. If it engages in...
economics question "A company is considering entering into a new marketing campaign. If it engages in this marketing campaign, it must pay $9,000 immediately and $7,000 each at the end of year 1 and year 2. The company believes its annual revenues due to the marketing campaign will be $11,000 at the end of year 1, $9,000 at the end of year 2, and $6,000 at the end of year 3. What is the annual equivalent worth of this marketing...
You are the marketing manager of a food product company that is considering entering the Indian...
You are the marketing manager of a food product company that is considering entering the Indian market. The retail system in India tends to be very fragmented. Also, retailers and wholesalers tend to have long-term ties with Indian food companies, these make access to distribution channels difficult. What distribution strategy would you advise the company to pursue? Why?
Suppose you are the chief marketing officer for an aviation-based company that is considering entering a...
Suppose you are the chief marketing officer for an aviation-based company that is considering entering a foreign market. Briefly, conduct a PESTLE analysis on the attractiveness of the foreign market. Be sure to identify both the company and the market/country. It can be either a real or hypothetical company. Discuss ethics considerations with each element. Limit your paper to 300 words, excluding references (no cover/title page is necessary). Format and cite your paper in current APA style, including Times New...
There has been much discussion in the news about the production and use of paper straws....
There has been much discussion in the news about the production and use of paper straws. Describe the market for plastic straws. Is there an externality associated with this market? If there is an externality, what type exists? What will this externality do to the market for plastic straws? Be sure to clearly describe the equilibrium price and quantity for the market in both cases (in presence and absence of the externality).
There has been much discussion in the news about the production and use of paper straws....
There has been much discussion in the news about the production and use of paper straws. Describe the market for plastic straws. Is there an externality associated with this market? If there is an externality, what type exists? What will this externality do to the market for plastic straws? Be sure to clearly describe the equilibrium price and quantity for the market in both cases (in presence and absence of the externality).
Over the years there has been much discussion about how to raise revenues in this country....
Over the years there has been much discussion about how to raise revenues in this country. Many alternative plans have been put forward arguing that there are much better ways to tax individuals then our current system. As you know these arguments, as you well know are taking hold on the state level. The states are looking at unique ways of both raising revenues and cutting budgets. Colorado and Washington tax marijuana, California taxes tattoos, Georgia is merging many of...
CASE STUDY FINANCIAL VIABILITY INDICATORS Kulula Ltd has been incorporated as an investment advisory company. The...
CASE STUDY FINANCIAL VIABILITY INDICATORS Kulula Ltd has been incorporated as an investment advisory company. The company sources for consulting services in investment appraisal and company valuation. You have recently joined the company as an investment analyst. You have been assigned to conduct an investment appraisal of two projects that a client is considering investing in. The two projects are tomato growing using drip irrigation and the second project is keeping layers for egg production. The initial investment required for...
recently there has been much public discussion and some proposed legislation concerning adults who use the...
recently there has been much public discussion and some proposed legislation concerning adults who use the internet to prey on children. Sociologist have also studied this problem. How do the goals of sociologists differ from those of journalist or talk show host in looking at this problem? With regard to internet predators, how does the information sociologists use differ from the information journalists and talk show host use?
You are part of an accounting firm Advisory team that has been engaged by a client...
You are part of an accounting firm Advisory team that has been engaged by a client to assess how they might make their “sales to order” process more “efficient”, perhaps with the introduction of new technologies. The client has provided a written description of their business, and the process under review, as follows: HHH is a small manufacturer of university based sportswear (a highly competitive market where fast response times are prized by customers). Sales span every region of the...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT