Exercise A 2: Absorption Costing Approach To Setting A Selli

1exercise A 2 Absorption Costing Approach To Setting A Selling Price

Martin Company is considering the introduction of a new product and needs to determine an appropriate selling price using the absorption costing approach. The company has provided key data: the projected annual production and sales volume of 10,000 units, a unit product cost of $50, projected annual selling and administrative expenses of $54,000, an estimated investment of $490,000, and a desired return on investment (ROI) of 18%. The task involves calculating the markup required to reach the target ROI and establishing a suitable selling price per unit based on absorption costing principles.

Paper For Above instruction

Pricing strategies are fundamental to the success of any business entity. They directly influence sales volume, profitability, market positioning, and long-term sustainability. Among various pricing approaches, absorption costing-based cost-plus pricing remains a widely used method, especially in manufacturing sectors where understanding the full cost—including fixed and variable costs—is essential for setting viable prices. This paper explores the application of the absorption costing approach to determine the adequate markup for a new product, aligning with the company's financial objectives and market realities.

Understanding the key components involved in absorption costing is essential. Absorption costing allocates all manufacturing costs, both variable and fixed, to the cost of products. When setting a selling price based on this approach, the company must ensure that the price covers the per-unit cost and contributes toward fixed costs and desired profit levels. The first step involves calculating the total cost per unit, which encompasses direct materials, direct labor, and allocated fixed manufacturing costs. In this scenario, the unit product cost is given as $50, indicating comprehensive absorption of manufacturing costs per unit.

To determine the markup required to achieve the desired return on investment (ROI), it's necessary to incorporate the investment and ROI into the pricing calculation. This involves calculating the amount of profit required to satisfy the ROI criterion, which is derived from the total investment and the target ROI percentage. Specifically, the profit necessary to meet the ROI is calculated as the product of the investment and the ROI percentage: $490,000 x 0.18 = $88,200. This amount represents the annual profit that the product must generate in addition to covering costs.

Given the annual sales volume of 10,000 units, the profit margin per unit needed to meet the ROI is obtained by dividing the total profit requirement by the total units: $88,200 / 10,000 units = $8.82 per unit. This indicates that each unit must generate an additional $8.82 above the unit cost to satisfy the ROI goal. Therefore, the target selling price per unit is the sum of the unit cost and the required profit per unit: $50 + $8.82 = $58.82.

However, to incorporate the markup percentage directly, the calculation involves deriving the markup based on the total investment and cost structure. The markup percentage is calculated as (Desired profit + fixed expenses) divided by the total manufacturing costs, expressed as a percentage of the cost. In this case, the markup percentage needed to achieve the ROI is approximately 17.64%, i.e., ($88,200 / (10,000 units x $50)) x 100. Adding this markup to the unit cost yields a selling price of approximately $58.82.

In conclusion, using the absorption costing approach for setting the selling price entails a thorough understanding of both the cost structure and financial objectives. By calculating the required markup to attain the return on investment, the company can establish a price that not only covers all costs but also ensures desired profitability levels. The calculated selling price of approximately $58.82 per unit offers a strategic benchmark that balances cost recovery with profit ambitions, supporting the company's long-term growth and competitiveness.

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