Question

Mary Williams, owner of Williams Products, is evaluating whether to introduce a new product line. After thinking through the production process and the costs of raw material and new equipment, Williams estimates the variable costs of each unit produced and sold at $6 and the fixed costs per year at $60,000.
a. If the selling price is set at $18 each, how many units must be produced and sold for Williams to break even?


b. Williams forecasts sales of 10,000 units for the first year if the selling price is set at $14 each. What would be the total contribution to profits from this new product during the first year?


c. If the selling price is set at $12.50, Williams forecasts that first-year sales would increase to 15,000 units. Which pricing strategy ($14.00 or $12.50) would result in the greater contribution to profits?


d. What other considerations would be crucial to the final decision about making and marketing the new product?

Answer 1

Answer:

Williams Products' Cost Elements:

Variable cost per unit = $6

Fixed Costs = $60,000

a) With selling price at $18, contribution margin = Selling price - Variable cost per unit = $12 $(18 - 6)

Break even point (in units) = Fixed Costs/Contribution Margin

= $60,000/$12 = 5,000 units

b) Forecast sales of 10,000 units with selling price at $14 each:

Total contribution to profits = Sales - Total Variable Costs

Sales = 10,000 x $14 = $140,000

Variable Costs = 10,000 x $6 = $60,000

Total Contribution = $80,000 (140,000 - 60,000)

c) Forecast sales of 15,000 units with selling price at $12.50 each:

Sales = 15,000 x $12.50 = $187,500

Variable Costs = 15,000 x $6 = $90,000

Total Contribution = $97,500.

Therefore, pricing at $12.50 each would result in the greater contribution to profits.

d) Other considerations crucial to the final decision about making and marketing the new product include: competitors' reactions to pricing, demand elasticity, consumers' preference, existing production technology, etc.

Explanation:

a) Contribution margin is equal to Selling price minus variable cost per unit.  This is the first element towards calculating break even point in units.

If 5,000 units are produced, total contribution would be equal to $60,000 ($12 x 5,000 units).

b) There are many pricing strategies which a producer can adopt depending on prevailing circumstances.  A few of them are price skimming, penetration pricing, price premium, price discrimination, value-based pricing, time-based pricing.