The Economists'Approach to Pricing;Absorption Costing Approach to Cost-Plus Pricing
Softway, Inc., was started by two young software engineers to market AdBlocker, a software application they had written that blocks ads when surfing the Internet. Sales of the software have been good at 20,000 units a month, but the company has been losing money as shown below
Sales (20,000 units x $18.95 per unit) | $379,000 |
Variable cost (20,000 units x $5.90 per unit) | 118,000 |
Contribution margin | 261,000 |
Fixed expenses | 264,000 |
Net operating income (loss) | $ (3,000) |
The company's only variable cost is the$5.90 fee it pays to another company to reproduce the software on CDs, print manuals, and package the result in an attractive box for sale to consumers. Monthly fixed selling and administrative expenses are $264,000.
The company's marketing manager has been arguing for some time that the software is priced too high. She estimates that every 10%decrease in price will yield a 20% increase in unit sales. The marketing manager would like your help in preparing a presentation to the company's owners concerning the pricing issue.
Required:
1. To help the marketing manager prepare for her presentation, she has asked you to fill in the blanks in the following table. The selling prices in the table were computed by successively decreasing the selling price by 10%. The estimated unit sales were computed by successively increasing the unit sales by 20%. For example, $17.06 is 10% less than $18.95 and 24,000 units are 20% more than 20,000 units.
Selling Price | Unit Sales | Sales | Variable Cost | Fixed Cost | Operating Income |
$18.95 | 20,000 | $379,000 | $118,000 | $264,000 | $(3,000) |
$17.06 | 24,000 | $409,440 | $141,600 | $264,000 | $3,840 |
$15.35 | 28,800 | ? | ? | ? | ? |
$13.82 | 34,560 | ? | ? | ? | ? |
$12.44 | 41,472 | ? | ? | ? | ? |
$11.20 | 49,766 | ? | ? | ? | ? |
$10.08 | 59,719 | ? | ? | ? | ? |
$9.07 | 71,663 | ? | ? | ? | ? |
$8.16 | 85,996 | ? | ? | ? | ? |
$7.34 | 103,195 | ? | ? | ? | ? |
2. Using the data from the table, construct a graph that shows the net operating income as a function of the selling price. Put the selling price on the X-axis and the net operating income on the Using the graph, estimate the approximate selling price at which net operating income is maximized.
3. Compute the price elasticity of demand for the Adblocker software. Based on this calculation, what is the profit-maximizing price?
4. The owners have invested S120.000 in the company and feel that they should be earning at least 2% per month on these funds. If the absorption costing approach to pricing were used, what would be the target selling price based on the current sales of 20.000 units? What do you think would happen to the net operating income of the company if this price were charged?
5. If the owners of the company are dissatisfied with the net operating income and return on investment at the selling price you computed in (3) above, should they increase the selling price? Explain.
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