ACCA PM Syllabus C. Decision-making Techniques - The Optimum Selling Price and Quantity - Past Papers ^{4 / 6}

TR Co is a pharmaceutical company which researches, develops and manufactures a wide range of drugs. One of these drugs, ‘Parapain’, is a pain relief drug used for the treatment of headaches and until last month TR Co had a patent on Parapain which prevented other companies from manufacturing it. The patent has now expired and several competitors have already entered the market with similar versions of Parapain, which are made using the same active ingredients.

TR Co is reviewing its pricing policy in light of the changing market. It has carried out some market research in an attempt to establish an optimum price for Parapain. The research has established that for every $2 decrease in price, demand would be expected to increase by 5,000 batches, with maximum demand for Parapain being one million batches.

Each batch of Parapain is currently made using the following materials:
Material Z:     500 grams at $0·10 per gram
Material Y:     300 grams at $0·50 per gram

Each batch of Parapain requires 20 minutes of machine time to make and the variable running costs for machine time are $6 per hour. The fixed production overhead cost is expected to be $2 per batch for the period, based on a budgeted production level of 250,000 batches.

The skilled workers who have been working on Parapain until now are being moved onto the production of TR Co’s new and unique anti-malaria drug which cost millions of dollars to develop. TR Co has obtained a patent for this revolutionary drug and it is expected to save millions of lives. No other similar drug exists and, whilst demand levels are unknown, the launch of the drug is eagerly anticipated all over the world.

Agency staff, who are completely new to the production of Parapain and cost $18 per hour, will be brought in to produce Parapain for the foreseeable future. Experience has shown there will be a significant learning curve involved in making Parapain as it is extremely difficult to handle. The first batch of Parapain made using one of the agency workers took 5 hours to make. However, it is believed that an 80% learning curve exists, in relation to production of the drug, and this will continue until the first 1,000 batches have been completed. TR Co’s management has said that any pricing decisions about Parapain should be based on the time it takes to make the 1,000th batch of the drug.

Note: The learning co-efficient, b = –0·321928

Required:
(a) Calculate the optimum (profit-maximising) selling price for Parapain and the resulting annual profit which TR Co will make from charging this price.

(b) Discuss and recommend whether market penetration or market skimming would be the most suitable pricing strategy for TR Co when launching the new anti-malaria drug. (8 marks)

Jewel Co is setting up an online business importing and selling jewellery headphones. The cost of each set of headphones varies depending on the number purchased, although they can only be purchased in batches of 1,000 units. It also has to pay import taxes which vary according to the quantity purchased.

Jewel Co has already carried out some market research and identified that sales quantities are expected to vary depending on the price charged. Consequently, the following data has been established for the first month:

Required:
(a) Calculate how many batches Jewel Co should import and sell. (6 marks)

Jewel Co is setting up an online business importing and selling jewellery headphones. The cost of each set of headphones varies depending on the number purchased, although they can only be purchased in batches of 1,000 units. It also has to pay import taxes which vary according to the quantity purchased.

Jewel Co has already carried out some market research and identified that sales quantities are expected to vary depending on the price charged. Consequently, the following data has been established for the first month:

Required:
(b) Explain why Jewel Co could not use the algebraic method to establish the optimum price for its product. (4 marks)

ALG Co is launching a new, innovative product onto the market and is trying to decide on the right launch price for the product.

The product’s expected life is three years.

Given the high level of costs which have been incurred in developing the product, ALG Co wants to ensure that it sets its price at the right level and has therefore consulted a market research company to help it do this.

The research, which relates to similar but not identical products launched by other companies, has revealed that at a price of $60, annual demand would be expected to be 250,000 units.

However, for every $2 increase in selling price, demand would be expected to fall by 2,000 units and for every $2 decrease in selling price, demand would be expected to increase by 2,000 units.

A forecast of the annual production costs which would be incurred by ALG Co in relation to the new product are as follows:

Required:
(b) Calculate the optimum (profit maximising) selling price for the new product AND calculate the resulting profit for the period.

Note: If P = a – bx then MR = a – 2bx. (7 marks)