The Fastener Company manufactures office equipment for retail stores. Carol Wats

Question

The Fastener Company manufactures office equipment for retail stores. Carol Watson, the vice president of marketing, has proposed that Fastener introduce two new products: an electric stapler and an electric pencil sharpener. Watson has requested that the Profit Planning Department develop preliminary selling prices for the two new products for her review.

Profit PLanning has followed the company's standard policy for developing potential selling prices. It has used all data available for each product. The data accumulated by Profit Planning are as follows:

Fastener plans to use an average of $1,200,000 in assets to support operations in the current year. The condensed budgeted income statement that follows reflects the planned return on assets of 20% ($240,000/$1,200,000) for the entire company for all products.

Fastener Company

Budgeted Income statement For the Year Ended May 31

( in thousands)

3. Which of the two pricing methods--return on assets pricing or gross margin pricing pricing---is more appropriate for decision analysis? Explain your answer

Electric Stapler Electric Pencil Sharpener Estimated annual demand in units 16,000 12,000 Estimated unit manufacturing costs $14 $15 Estimated unit selling and administrative expenses $3 N/A Assets employed in manufacturing $160,000 N/A

Explanation / Answer

Gross Margin Pricing- It is basically a cost based pricing method that sets the selling price at a desired percentage above the total production cost.The income statement information is used to compute selling price.

First we calculate markup %=Desired Profit+Total selling and Administrative Expenses/Total production cost.

Gross margin-based price= Total production Cost per unit+(Markup %*total production cost per unit)

Return on Assets pricing is based on a specific rate of return on assets which re employed in making of a product.The company has a minimum rate of return which it expects from its from its assets put to use, This is a Balance sheet method as it uses the specified rate of return to be earned on the assets used. The formula is

1)Return on Assets-Based price=Total cost and Expenses per unit +(Desired rate of Return*Cost of assets employed per unit

2) Formula Return on Assets-Based price= (Total production cost+ Total Selling and administrative expenses)/Units to be produced+(Desired rate of Return *(Total cost of assets employed/Units to be produced).

Gross margin pricing is better for decision analysis as it takes into account total product cost which can be known easily, as it is available in the market. As compare to return on assets for which it is comparatively not that easy as it involves the specific assets to be identified which is related to manufacture of the product and the cost associated with it.

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