Cost-Plus Pricing. Emerson Ventures is considering producing a new line of hang gliders. The company estimates that variable costs will be $325 per unit and fixed costs will be $330,000 per year.
a. Emerson has a pricing policy that dictates that a product's price must be equal to full cost plus 60 percent. To calculate full cost, Emerson must estimate the number of unites it will produce and sell in a year. Emerson estimates at the beginning of the year that they will sell 1,500 gliders and sets their price according to that sales and production volume. What is the price?
b. Right after the beginning of the year, the economy takes a dive and Emerson finds that demand for their gliders has fallen drastically; Emerson revises its sales and production estimate to just 1,000 gliders for the year. According to company policy, what price must they now set?
c. What is likely to happen to the number of gliders sold if Emerson follows company policy and raises the glider price to that calculated in part b?
d. Why is setting price by marking up cost inherently circular for a manufacturing firm?
The solution explains some calculations relating to cost plus pricing
The Cost of Capital
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1. Read the attached Economist magazine article on real estate prices and answer the following two questions:
· Discuss at least one factor that has an influence on housing demand that was not given much weight in the article.
· Discuss at least one factor that has an influence on housing supply that was not mentioned in the article.
2. Given the following information on a real multifamily property for sale:
· Asking price: $389,000
· Number of units: 4
· Monthly rent per unit: $625 on one unit; $650 on two units; $675 on one unit
· Square feet per unit: 1,000
· Annual tax expense: $2,960
· Annual insurance expense: $750
· Annual utilities expense: $3,456
· Vacancy rate: 5%
· Assume an interest-only mortgage
· Assume no closing costs
· Analyze first year cash flows only
At what cost of capital does this property produce a net positive cash flow? Does it produce a positive first year cash flow at a 6.5% cost of capital? What other factors will you take into account if you were trying to acquire this property for investment purposes? Show all work in Excel file with included brief discussion.
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