Wendel Stove Company is developing a \"professional\" model stove aimed at the h

Question

Wendel Stove Company is developing a "professional" model stove aimed at the hoem market. The company estimates that variable costs will be $2,000 per unit and fixed costs will be $10,000,000 per year.

Required

A. Suppose the company wants to set it's price equal to full cost plus 30 percent. To determine cost, the company must estimate the number of units it will produce and sell in a year. Suppose the company estimates that it can sell 5,000 units. What price will the company set?

B. What is "odd" anout setting the price based on an estimate of how many units will be sold?

C. Suppose the company sets a price as in part A, but the number of units demanded at that price turns out to be 4,000. Revise the price in light of demand for 4,000 units?

D. What will happen to the number of units that will be sold if the price is raised to the one you calculated in part C.
E. Explain why setting price by marking up cost is inherently circular for a manufacturing firm?
Wendel Stove Company is developing a "professional" model stove aimed at the hoem market. The company estimates that variable costs will be $2,000 per unit and fixed costs will be $10,000,000 per year.

Required

A. Suppose the company wants to set it's price equal to full cost plus 30 percent. To determine cost, the company must estimate the number of units it will produce and sell in a year. Suppose the company estimates that it can sell 5,000 units. What price will the company set?

B. What is "odd" anout setting the price based on an estimate of how many units will be sold?

C. Suppose the company sets a price as in part A, but the number of units demanded at that price turns out to be 4,000. Revise the price in light of demand for 4,000 units?

D. What will happen to the number of units that will be sold if the price is raised to the one you calculated in part C.
E. Explain why setting price by marking up cost is inherently circular for a manufacturing firm?

Explanation / Answer

a. For 5000 units VC = 5000*$2000 = $10,000,000 FC = $10,000,000 -------------------------- Total Cost = $20,000,000 so per units cost = $20,000,000/5000 = $4000 As Sale price is Full cost + 30% = $4000+30%*4000 = $5200 b. Odd thing is company is setting the price based on demand & not on productaion capacity. If company has less capacity, it may not Breakeven as FC are $10M. On the other hand, if company has a large capacity, idle capacity will result in losses c. 4000 Units As company has already Mfd 5000 units at a cost of $20M, but it can sell only 4000 units. Per unit SP = $20M/4000 = $5000 As Sale price is Full cost + 30% = $5000+30%*5000 = $6500 d. As the SP is high, the demand for units will fall resulting in further increase in price & further reduction in demand. This it will becoem a circular effect. e. If Marking up price is used by a Mfg firm, it will affect its demand for produtc. A reduction in demand, will resultin prce increase & will further reduce demand.. This circular effect may lead to closure. Hence company must use mkt survey to assess demand & then work out the production costs. if the prce is high than mkt can absorb, company should look at means to reduce FC or introdcuing a product mix to rationalise the FCs.

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