Emerson ventures is considering producing a new line of hang gliders. The compan
ID: 2665567 • Letter: E
Question
Emerson ventures is considering producing a new line of hang gliders. The company estimataes that variable costs will be $325 per unit and fixed costs will be $330,000 per year.a. Emerson has a pricing policy that dictates that a product's price must be equal to full cost plus 60%. To calculate full cost, emerson must estimate the # of units it will produce & sel in a year. Emerson estimates at the beginning of the year that they will sell 1,500 gliders & sets their price accorindingly. What is the price?
b. Right after the beginning of the year, the economy takes a dive & emerson finds that demand for their gliders has fallen. Emerson revises its sales & production estimate to just 1,000 gliders for the year. According to the company policy, what price must they now set?
c. What is likely to happen t othe # of gliders sold if emerson follows company policy & raises the glider prrice to that in part b?
d. Why is setting price by marking up cost inherently circular for a manufacturing firm?
Explanation / Answer
a.
Variable cost per unit
$ 325
Fixed cost per unit ($330,000 ÷ 1,500)
220
Total
$ 545
Markup of 60%
327
Price
$ 872
b.
Variable cost per unit
$ 325
Fixed cost per unit ($330,000 ÷ 1,000)
330
Total
$ 655
Markup of 60%
393
Price
$ 1,048
c. The price in the second scenario is higher because the fixed costs are being spread over fewer units. As the cost goes up, so does the markup and price. However, if price goes up, demand is likely to fall, so the company will not sell as many units as previously estimated.
d. This situation can turn into a “death spiral,” in that as the cost goes higher, the company sets the price higher, reducing demand further, which in turn drives up cost. It is a vicious cycle in which the company is eventually forced out of the market.
Variable cost per unit
$ 325
Fixed cost per unit ($330,000 ÷ 1,500)
220
Total
$ 545
Markup of 60%
327
Price
$ 872
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