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Relevent-cost approach to pricing decisions

Stardom Inc. cans peaches for sale to food distributors. All costs are classified as either
manufacturing or marketing. Stardom prepares monthly budgets. Its March 19X6 budgeted
absorption-costing income statement follows:
Revenues (1,000 crates at $100 a crate) $100,000
Cost of goods sold $60,000
Gross margin $40,000
Marketing costs $30,000
Operating income $10,000
Normal markup percentage:
$40,000 - $60,000 = 66.7% of absorption cost
Monthly costs are classified as fixed or variable (with respect to the cans produced!
Manufacturing costs and with respect to the cans sold for marketing costs):
Fixed Variable
Manufacturing $20,000 $40,000
Marketing 16,000 14,000
Stardom has the capacity to can 1,500 crates per month. The relevant range in which
monthly fixed manufacturing costs will be "fixed" is from 500 crates to 1,500 crates per
a) Calculate the markup percentage based on total variable costs.

b) Assume that a new customer approaches Stardom to buy 200 crates at $55 per crate for cash. The customer does not require additional marketing effort. Additional manufacturing
costs of $2,000 (for special packaging) will be required. Stardom believes that this is a onetime-
only special order, because the customer is discontinuing business in six weeks' time.
Stardom is reluctant to accept this 200-crate special order because the $55 per-crate price is
below the $60 per-crate absorption cost. Do you agree with this reasoning? Explain.

c) Assume that the new customer decides to remain in business. How would this longevity
affect your willingness to accept the $55 per-crate offer? Explain


Solution Preview

a) Total variable costs are 40,000+14,000 = 54,000
The contribution margin is 100,000-54,000=46,000
The markup percentage on variable cost is 46,000/54,000=0.852= 85.2%

b) The reasoning is not correct. A special order is to be evaluated based on variable costs ...

Solution Summary

The solution explains some questions relating to pricing decisions