Wendel Stove Company is developing a “professional” model stove aimed at the hom

Question

Wendel Stove Company is developing a “professional” model stove aimed at the home market. The company estimates that variable costs will be $2,000 peer unit and fixed costs will be $10,000.000 per year.

Required to answer:

a. Suppose the company wants to set it 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” about 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 marketing up cost is inherently circular for a manufacturing firm.

Explanation / Answer

a) SP = (FC/Q +VC)*mark up factor, k (per unit values) SP = (10000000/5000 + 2000)*1.3 (k = 1.3, as cost plus 30% is SP) => = (2000+2000)*1.3 = 5200 ($) (ANSWER) b) The price may sometimes be high based on estimates of sale quantity if it is less than BEP and actual demand at the set price may be less than estimated. (BEP in a) above = 10000000/(5200-2000) = 3125 and 5000 is ok.) c) for 4000 units, SP = (10000000/4000+2000)*1.3 =5850 ($) (ANSWER) d) With increased price, demand may fall further. e) With lower Q, FC per unit will increase and thereby SP will increase which further lower Q and a vicious circle will be formed.

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