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Pricing Decision and Investment Evaluations

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Managers should base pricing decisions on both cost and market factors. In addition, they must also consider legal issues. Describe the influence that the law has on pricing decision.

"It is impossible to use DCF (Discounted cash flow) methods for evaluating investments in research and development. There are no cost savings to measure, and we don't even know what products might come out of our R&D activities." This is a quote from an R&D manager. How can they justify investing in a major research project based on its expected net present value? Explain how this can be done please, and if you were that manager would you have your resume ready to go out?

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The influence of law on prices can be seen in the following ways -

a. Anti-trust Laws - These check the price that can be charged by the company. If any unfair pricing is indicated then action can be taken against the firm.

b. Regulatory pricing - Many times the government sets the price that can be charged as was the case with electricity regulation.

c. Anti-dumping laws - These laws state that the price cannot be below cost

d. A law which prohibits discrimination in prices between different purchasers ( Robinson-Pitman Act)

The DCF methodology can be applied to R&D activities in 2 ways.

First method applicable to historical costs - the historical costs of R&D can be measured against ...

Solution Summary

The solution explains pricing decisions and how discounted cash flows can be used for R&D in 441 words.

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Capital investment evaluation for mutually exclusive project

20.) Miller Electronics is considering two new investments. Project C calls for the purchase of a coolant recovery system. Project H represents an investment in a heat recovery system. The firm wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows:
Project C ($25,000 investment) Project H ($25,000 investment)
Year Cash Flow Year Cash Flow
1 $ 6,000 1 $20,000
2 7,000 2 6,000
3 9,000 3 5,000
4 13,000
a.Determine the net present value of the projects based on a zero discount rate.

b. Determine the net present value of the projects based on a 9 percent discount rate.

c. The internal rate of return on Project C is 13.01 percent, and the internal rate of return on Project H is 15.68 percent. Graph a net present value profile for the two investments similar to Figure 12-3. (Use a scale up to $10,000 on the vertical axis, with $2,000 increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent increments.)

d. If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if the cost of capital (discount rate) is 8 percent? (Use the net present value profile for your decision; no actual numbers are necessary.)

e. If the two projects are mutually exclusive (the selection of one precludes the selection of the other), what would be your decision if the cost of capital is (1) 5 percent, (2) 13 percent, (3) 19 percent? Use the net present value profile for your answer.

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