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.
A new technique for estimating the probability of achieving target sales and profits will be discussed. This requires managers to estimate demand for the new product and assign probabilities. A range, rather than only one goal will be established.
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 $200. With the higher selling price the annual fixed costs would increase to $25,000,000. The marketing department are adamant that increased emphasis on advertising and promotions is essential.
The following probability distributions have been agreed with the managers after consultation with all departments and is the same for both selling prices.
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Estimated demand (units)
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Estimated probability (units)
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150,000
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0.25
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180,000
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0.5
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200,000
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0.25
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Additional information:
- The estimate or variable cost per unit is $30.
- The probability of the new product achieving break-even is very important. A profit greater than $4,000,000 is expected.
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.
- 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 helpful for this type of decisions. 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.