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Pricing in a Tight Market

Gargantuan Industries is a multi product company with several manufacturing plants. The Boise Plant manufactures and distributes two household cleaning and polishing compounds, standard and commercial, under the Super Clean label. The forecasted operating results for the first six months of the current year, when 100,000 cases of each compound are expected to be manufactured and sold, are presented in the following statement.

"SUPER CLEAN COMPOUNDS—BOISE PLANT
Forecasted Results of Operations
For the Six-Month Period Ending June 30
(in Thousands)"
Standard Commercial Total
Sales ............................................................................................. 2,000.00 3,000.00 5,000.00
Cost of goods sold..................................................................... 1,600.00 1,900.00 3,500.00
Gross Profit ........................................................................ 400.00 1,100.00 1,500.00
Seling and Administrative Expenses:
Variable ................................................................................. 400.00 700.00 1,100.00
Fixed* .................................................................................... 240.00 360.00 600.00
Total selling and administrative expenses 640.00 1,060.00 1,700.00
Income (loss) before taxes .................................................... (240.00) 40.00 (200.00)

*The fixed selling and administrative expenses are allocated between the two products on the basis of dollar sales volume.

The standard compound sold for $20 a case and the commercial compound sold for $30 a case during the first six months of the year. The manufacturing costs, by case of product, are presented in the schedule below. Each product is manufactured on a separate production line. Annual normal manufacturing capacity is 200,000 cases of each product. However, the plant is capable of producing 250,000 cases of standard compound and 350,000 cases of commercial compound annually.

Cost Per Case
Standard Commercial
Direct Material $7.00 $8.00
Direct Labor $4.00 $4.00
Variable manufacturing Overhead $1.00 $2.00
Fixed manufacturing Overhead* $4.00 $5.00
Total Manufacturing Cost $16.00 $19.00
Variable Selling and Administrative Costs $4.00 $7.00

*Depreciation charges are 50 percent of the fixed manufacturing overhead of each line.

The following schedule reflects the consensus of top management regarding the price-volume alternatives for the Super Clean products for the last six months of the current year. These are essentially the same alternatives management had during the first six months of the year.

Standard Compound Commercial Compound
Alternative Prices (per case) Sales Volume(in cases) Alternative Prices (per case) Sales Volume(in cases)
$18.00 120,000.00 $25.00 175,000.00
$20.00 100,000.00 $27.00 140,000.00
$21.00 90,000.00 $30.00 100,000.00
$22.00 80,000.00 $32.00 55,000.00
$23.00 50,000.00 $35.00 35,000.00

Gargantuan's top management believes the loss for the first six months reflects a tight profit margin caused by intense competition. Management also believes that many companies will leave this market by next year and profit should improve.

Required:
1. What unit selling price should Gargantuan Industries select for each of the Super Clean compounds for the remaining six months of the year? Support your selection with appropriate calculations.

2. Independently of your answer to requirement (1), assume the optimum alternatives for the last six months were as follows: a selling price of $23 and volume of 50,000 cases for the standard compound, and a selling price of $35 and volume of 35,000 cases for the commercial compound.

a. Should Gargantuan Industries consider closing down its operations until January 1 of the next year in order to minimize its losses? Support your answer with appropriate calculations.

b. Identify and discuss the qualitative factors that should be considered in deciding whether the Boise Plant should be closed down during the last six months of the current year.

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Solution Summary

Solution determines the price for the given products based upon the cost data provided. It also determines if it is advisable to shut down the operations for some time in the proposed scenario of price and output.

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