Cost Accounting-A meeting of senior managers at the Pringly Division has been

QUESTION

Pringly Division
A meeting of senior managers at the Pringly
Division has been called to discuss the pricing strategy for a new product.
Part of the discussion will focus on estimating sales for the new product. Over
the past years, a number of new products have failed to meet their sales
targets. It appears that the company’s profit for the year will be lower than
budget and the main reason for this is the disappointing sales of new products.
This time a range of possible sales targets –
rather than only one goal – will be established and evaluated.
The first strategy is to set a selling price
of $170 with annual fixed costs at $20,000,000. A number of managers are in
favor of this strategy, as they believe it is important to reduce costs.
The second strategy is to increase spending on
advertising and promotions and set a selling price of $220. With the higher
selling price the annual fixed costs would increase to $25,000,000. The
marketing department is adamant that increased emphasis on advertising and promotions
is essential.
The table below shows three probable levels of
customer demands. The likelihood of reaching a certain level is indicated by
the estimated probability. Note that it is not necessary to create a complex
model based on probabilities. However, the probability distribution provides
some guidance for the managers. Don’t forget that the company has certain
minimum expectations of a new product.

Estimated demand (units)

Estimated probability (units)*

150,000

0.25

180,000

0.5

200,000

0.25

*Estimated probabilities are given to assist
in making a final recommendation. These probabilities don’t have to be
incorporated into a model, just considered in the final recommendation.
Additional information:
·
The estimate of
variable cost per unit is $35.
·
The probability of the
new product achieving break-even is very important. A profit greater than
$4,000,000 is expected.
Case Assignment
Required:
·
Compute break-even at
each level.
·
Is the company likely
to achieve its desired target profit of $4,000,000 or more? Support your
discussion with financial analysis.
·
Compute the margin of
safety and explain the meaning of the number derived.
·
Should the company go
ahead with the new product?
·
Would this type of
analysis be useful to a large company with a wide range of products?
·
ROI (return on
investment) and residual income are two other methods that can be helpful for
this type of decision. Could they be applied in this situation? Support your
answer with financial analysis.
HINT: Don’t forget to use the variable costing approach for your
analysis.
Assignment Expectations
It is important to answer the questions as
posed. The discussion should be 4 to 6 pages and written in a clear
and concise manner. Support your discussion with references in APA format. You
are encouraged to use Excel or other compatible spreadsheet when computations
are involved.

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