Cost-Plus Pricing

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:

Price-Setter: Cost-Plus Pricing
Selling price per unit$30
Sales in units5,000
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:
-
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:

Calculation of New Selling Price
Variable costs$100,0005,000 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 units5,000unit 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 unitCalculations
Budgeted Income Statement 2017
Sales
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$160,000$325,000 units x $32
Variable costs:
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-
-
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Direct materials
$35,000
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$75,000 units x $7
Direct labor
$30,000
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$65,000 units x $6
Variable factory overhead
$25,000
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$55,000 units x $5
Variable selling expenses
$10,000
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$25,000 units x $2
Total variable expenses
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$100,000
-
-
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
-
$40,000
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$60,000 - $20,000