stdntrwk 4

7/17/2019 StdntrWk 4

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Unit Costs & PricingDecisions.Lecturer: Vijay Shah

Lecture 5 Managing Finance.

Week - 4



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Defnition:

‘A cost unit is a unit of product or servicefor which the cost is computed.

!!" Managing Finance" !#$%

Unit Cost.

• Unit selected has to be appropriate to the business.

• Expenditures related to that unit should be readily/easily calculated (1 litre

o paint or a paint !anuacturer and cost o car or a car !anuacturer

are ob"ious unit ite!s that costs should be calculated or#.• $are has to applied to selectin% a unit e.%. & transport co!pany usin% a

tonne o car%o 'ill be inappropriate as ) tonne !o"ed ro! *las%o' to

+ondon 'ould cost !ore than *las%o' to Edinbur%h. & better unit !i%ht

be ,onne-ile.



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• F&ogg&es ' (o. Ma)e p&astic food containers of di*erent si+es.

• ,he factory contains - departments:

• Mou&ding ept

• Finishing ept.

• /ach 0atch of #11 medium si+ed 0o2es uses 314g of p&astic costing1.$6)g

• La0our time for each 0atch is #.5hrs" paid at 7.-16hr

• 8inges for 0o2es cost #5651pairs. /ach 0o2 uses # pair of hinges

• 9oya&ties are paya0&e on the hinges at 1.#16pair used inmanufacture of the containers60o2es.

• /ach 0atch ta)es -1 mins to go through the nishing departmentwhere &a0our costs are ;.$16hr.

• ,ota& factory indirect costs for the ne2t period are 7"511.

• -11 0atches of medium si+ed 0o2es wi&& 0e made in the ne2tperiod.

• $1< of the indirect costs are attri0uted to the Mou&dingdepartment" and 31< to the Finishing department.

Qu. Calculate the Product cost o a batch o 100 mediumsized boxes.

nit Costcont’d



Defnitions:

ariable cost is that part of cost which varies withthe vo&ume of production =or &eve& of activity>.

!ixed cost is that part of cost which does not varywith the &eve& of activity or vo&ume of production.

"emi#$ariable =or semi?2ed or mi2ed> costs arepart&y varia0&e and part&y 2ed.

Fixed and Variable Costs



• irect costs wi&& rise as more units of product are made"hence varia0&e costs wi&& depend on how much you ma)e

• Sa&es commission often varies with sa&es made" so this isa varia0&e cost %ith sales but not %ith roduction.

• ,e&ephone ca&& costs are &i)e&y to increase withincreases6e2pansion o f the 0usiness. 8ence they arevaria0&e overhead costs" varying with production andsa&es.

• 9enta& costs of a 0usiness for a given period of time areconstant so these are 2ed costs as they do not varywith &eve& of activity =production or sa&es> for that period.


co ’d



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co ’d

&ndre' has a !obile phone 'here he pays !onthly char%e o 2.

$alls or the irst units are p/unit and thereater at 4p/unit or any

one !onth.

Work out the annual cost or &ndre' or

1. 2 units o calls per !onth

2. units o calls per !onth



• 'his is a method %e all use all the time

• (.g. ) *ou %ere o+ered to %or, outsidenormal hours or an extra -1hr and thismeant coming in to %or,.

• 'hen i *our train tic,et %as -/ then it %ouldonl* be %orth it i *ou %ere to %or, morethan / hrs.

• "a* *ou %or,ed hrs then:

Cost o tic,et -/eneft o hrs o %or, -

2et beneft o extra a* -1

Cost Benefit Analysis



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'here are roblems %ith this:

• i@cu&ty in identifying costs that are re&evant to adecision.

• Some costs cannot 0e e2pressed in money terms. f

you were as)ed to do overtime at the wee)?end 0utyou had a sic) parent that you needed to &oo) after atthat wee)?end " how much wou&d you va&ue this at =ifnot a dear re&ative then one might say at the cost ofgetting some?one e&se to &oo) after the parent>.

• Sometimes the enefts can 0e hard to Buantify i.e.enet of wor)ing overtime might 0e the satisfactionof nishing the jo0" how does one va&ue thisC

Cost Benefit Analysis

cont’d.



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Relevant Costs- Definitions

,he costs which shou&d 0e used for decision

ma)ing are often referred to as rele$ant costs.

a. 9e&evant cost is a future costs

i. A decision is made a0out the futureD it cannot a&ter whathas 0een done a&ready. A cost that has a&ready 0eenincurred in the past is tota&&y irre&evant to any decisionthat is 0eing made now.

ii. (ost that have 0een incurred inc&ude not on&y costs thathave a&ready 0een paid" 0ut a&so costs that are su0ject to

&ega& 0inding contracts" even if payments due undercontract have not 0een incurred =these are )nown ascommitted costs>.



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Relevant Costs- Definitions

0. 9e&evant costs are cash 3o%s. Usuall* related to dereciation.

Say you 0uy a car for #1"111 and you depreciate this over 3 yrs i.e.

-"5116yr.

,his means you deduct -"5116yr from your annua& prots" this is

on&y a cost on paper. ,he rea& cost is #1"111 that got deducted from

your account when you 0ought the car.

c. 9e&evant cost is one which arises as a direct conseBuence of adecision. 8ence on&y costs which wi&& di*er under some or a&& of the

avai&a0&e opportunities shou&d 0e consideredD re&evant costs aretherefore sometimes referred to as incrementa& costs or di*erentia&

costs.

(.g. f an emp&oyee wi&& attend ne2t wee) with no wor) to do at a

wage of E11. ,hen his supervisor might give him a jo0 that wi&& earna 31 prot. ,he E11 cost is irre&evant to the decision as this is afuture cash?ow cost that wi&& 0e incurred irrespective of decision to

give him wor) or not.



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Non-Relevant Costs

,hese irrele"ant costs or decision-!akin% because they do not aect uturecash-lo's or costs that 'ill be incurred any'ay re%ardless o decisions

!ade.

Sunk costs are assets already ac6uired but has no realisable "alue (i.e.

has not resale "alue or inco!e "alue ro! any other alternati"e purpose#.

Example: & co!pany purchases a !achine or 2 so!e ti!e a%o it

has already been depreciated do'n to 0 but it has no resale "alue

due to ne'er better !achines bein% a"ailable or that purpose.

,he co!pany is considerin% purchasin% a ne' !achine and scrappin% the

existin% one.

,he current book "alue o 0 is sunk cost. ,he 'ritin%-o the !achine

and incurrin% a paper loss o 0 is irrele"ant to the decision-!akin%

process.



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Non-Relevant Costs

Committed Cost

,his is a uture cash outlo' that 'ill be incurred any'ay no !atter 'hat decision is !ade

re%ardin% alternati"e opportunities.

,hese !ay exist because contracts ha"e already been entered to 'hich there is a

co!!it!ent.

Notional Cost

7ypothetical accountin% cost to relect so!ethin% or 'hich no actual cash expense isincurred e.%.• 8otional rent 'hich is char%e to a business unit treated as proit centre but the buildin%

is o'ned by the co!pany• 8otional interest char%ed to a business unit treated as proit centre but capital is !ade

a"ailable by the co!pany head-oice.

Note: 9ariable costs are relevant costs.:ixed costs are irrelevant costs.

Direct and Indirect costs !ay be relevant or irrelevant. E.%. +abour i paid irrespecti"e

o 'ork done or not is irrele"ant cost addin% another person to the ;ob 'ould incur

costs hence this is a rele"ant cost.



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Pricing Decisions



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Price Leadership+ar%e corporations tend to be price leaders. <ther s!aller co!panies tend to ollo' the

leader=s price settin%. +eader oten bein% the brand or 6uality leader.

E.%.

) a ollo'er tried to raise the price abo"e the price-leader and the leader did not ollo'

then the price increases 'ould be halted.

7a"e you noticed that 'hen 1 super!arket petrol station increases price the others

ollo'.

arket Penetration Pricing

,his is char%in% lo' prices 'hen a ne' product enters the !arket or is launched. ,his

is done to obtain sales or !arket share in order to penetrate the !arket. ay be

appropriate in circu!stances

• Existin% ir! 'ishes to discoura%e ne' ir!s enterin% the !arket• :ir! 'ishes to shorten initial period o >roduct=s +ie $ycle to enter *ro'th or aturity sta%es

sooner.• ,o obtain econo!ies o scale throu%h hi%h sales "olu!es• ) de!and is likely to increase due to all in prices



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arket Skimming Pricing

,his in"ol"es char%in% hi%h prices 'hen a ne' product is irst launched and

spendin% hea"ily on ad"ertisin% and sales pro!otion to obtain sales.

&s the product !o"es into %ro'th !aturity and decline lo'er prices 'ill be

char%ed.

?tudent exercise

$an you na!e a product that incurred a hi%her price at launch 'hy do youthink the ir! 'as able to char%e the hi%her price@



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Price Leadership

,his is 'here a lar%e corporation 'ith lar%e !arket share e!er%e as price

leaders.>rice leader indicate to the price and co!petitors set their price 'ith reerence

to leader=s price.

) lo'er le"el co!petitors raise prices abo"e the leader and the leader does not

ollo' then it=s likely that co!petitor 'ill e"entually brin% his/her price do'n.

Arand leaders are oten cost leaders due to econo!ies o scale etc. & !arket

'ith !any si!ilar suppliers to the !arket the 'eaker is the role o the price

leader.

arket Penetration Pricing,his is 'here co!pany char%es lo' prices in order to break into the !arket and

take custo!ers ro! existin% co!petitors in the !arket.



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ark!Up Pricing,his 'here the co!pany adds proit on top o the ull product cost.

Student Exercise

$o!pany bud%ets to !ake 1 units/yr 'ith "ariable cost o 3/unit and

ixed cost o /yr. )t decides to ix a proit !ar%in o 33 .33333B .

$alculate the ull cost and then the price o one product.



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Ausiness Essentials ?upportin% 78C@78$ and :oundation Ce%rees.

Managing Finance. A>> +earnin% edia.

!repared 0y: Gohn Hwen ' VijayShah

"e#erences

stdntrwk 4

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