Lecture 13

Question 1

Full-cost Plus advantages and disadvantages

Answer 1

Advantages
Covers all fixed costs and makes a profit (when a company is working at normal capacity)
Simple, quick and cheap method
Can justify prices
Flexible – can cope with differing mark-up %s

Disadvantages
Must be large enough to cover non-production costs
Too simplistic to reflect demand and market conditions
Pricing problem looks deceptively simple - Fails to recognise that since demand may be determined by price, there is a profit –maximising combination of price and demand. The Cost –plus approach is most unlikely to arrive at this price

Question 2

Marginal Cost-plus Pricing/Mark-up pricing

Answer 2

Adding a profit margin onto marginal cost (either marginal cost of production or marginal cost of sales)

Question 3

Full-Cost Plus Pricing formula

Answer 3

Sales price = Full cost + % mark-up

Question 4

Pros and cons of Marginal cost plus pricing

Answer 4

Advantages
Simple and easy
Mark-up can be adjusted to reflect demand conditions
Draws management attention to contribution and the effects of higher or lower sales volume on profit
Convenient when readily identifiable variable costs.

Disadvantages
Although you can vary mark-up in accordance with demand conditions it does not pay sufficient attention to demand conditions, competitors’ prices and profit maximisation.
It ignores fixed overheads – so how can you be sure we’re covering them!