A company that is a price-setter has control over the prices of its product; it has a unique product or service with little competition. The company will use cost-plus pricing to calculate the selling price needed to meet its desired profit.
Assume that the company from the previous example sells a product with a market value of $30, but the company is a price-setter. Other information provided by the company is shown below:
Selling price per unit | $30 |
Sales in units | 5,000 |
Variable expenses per unit: |
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Direct materials | $7 |
Direct labor | $6 |
Variable factory overhead | $5 |
Variable selling expense | $2 |
Total variable expenses | $20 |
Fixed expenses: |
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Fixed factory overhead | $13,000 |
Fixed selling and administrative expenses | $7,000 |
Total fixed expenses | $20,000 |
Average total assets | $250,000 |
Expected return on investment (ROI) | 16% |
The company’s stockholders expect a 16% ROI. The company has $250,000 in average assets; therefore, the company’s desired profit is $40,000 ($250,000 times 16%). The calculation for the new selling price is shown below:
Variable costs | $100,000 | 5,000 units x $20 per unit |
Fixed costs | $20,000 |
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Full product cost | $120,000 | $100,000 + $20,000 |
Desired operating income | $40,000 | $250,000 x 16% |
Target revenue | $160,000 | $120,000 + $40,000 |
Number of units | 5,000 | unit sales |
Cost-plus price per guest | $32.00 | $160,000 / 5,000 units |
If the company increases the selling price from $30 to $32, it will reach its desired profit of $40,000. See below:
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| Per unit | Calculations |
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Sales |
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| $160,000 | $32 | 5,000 units x $32 |
Variable costs: |
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Direct materials
| $35,000 |
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| $7 | 5,000 units x $7 |
Direct labor
| $30,000 |
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| $6 | 5,000 units x $6 |
Variable factory overhead
| $25,000 |
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| $5 | 5,000 units x $5 |
Variable selling expenses
| $10,000 |
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| $2 | 5,000 units x $2 |
Total variable expenses |
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| $100,000 |
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Contribution margin |
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| $60,000 | $10 | $160,000 - $100,000 |
Fixed factory overhead | $13,000 |
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Fixed selling and administrative expenses | $7,000 |
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Total fixed costs |
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| $20,000 |
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| $13,000 + $7,000 |
Operating income |
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| $40,000 |
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| $60,000 - $20,000 |