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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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Discuss Drawem Company's financial reporting and performance evaluation program as it relates to the responsibilities of Bildem Division.

Drawem Company purchased Bildem Company three years ago. Prior to the acquisition, Bildem manufactured and sold electronic products to third-part customers. Since becoming a division of Drawem, Bildem now manufactures electronic components only for products made by Drawem's Macon Division.
Drawem's corporate management fives the Bildem Division management considerable latitude in running the division's operations. However, corporate management retains authority for decisions regarding capital investments, product pricing, and production quantities.
Drawem has a formal performance evaluation program for all divisional management teams that relies substantially on each division's ROI. Bildem division's income statement provides the basis for the evaluation of its divisional management (See the following income statement)
The corporate accounting staff prepares the decision's financial statements. Corporate general services costs are allocated on the basis of sales dollars, and the computer department's actual cost are apportioned among the divisions on the basis of use. The net division investment includes division fixed assets at net book value (cost less depreciation), division inventory, and corporate working capital apportioned to the divisions on the basis of sales dollars

a. Discuss Drawem Company's financial reporting and performance evaluation program as it relates to the responsibilities of Bildem Division.

b. Based on the response to requirement (a), write a memo to management recommending appropriate revisions of the financial information and reports used to evaluate the performance of Bildem's divisional management. If revisions are not necessary, explain why.

Bildem Division
Income Statement
For the year Ended June 30
(in thousand)

Sales Revenue $8,000
Cost and expenses:
Product Cost:
Direct material $1,000
Direct labor 2,200
Manufacturing overhead 2,600
Total $5,800
Less: Increase in inventory 700 5,100
Engineering and research 240
Shipping and receiving 480
Division administration:
Manager's office $420
Cost management 80
Human services 164 664
Corporate cost:
General services $460
Computer 96 556
Total costs and expenses $7,040
Divisional operating profit $960
Net plant investment $3,200
Return on investment 30%

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