Solution
David answered on Dec 24 2017
Case Study 1:
Answer 1:
As per the information provided in Table 1 of the case study Hot water Limited should go for following pricing strategy during three year period of sales:
a) Pricing at a Premium: In 2019, the company expects to enter market with new product Rayhot. Since the product is new with unique features with very few competition in the market, the company can afford to charge a premium price for the product. Proposed selling price in 2019 for $ 1,000 will enable to earn a premium which is greater than company minimum required rate of return.
) Pricing For Market Penetration: In 2020, company expects to increase sales to 17,000 units by reducing price. This pricing strategy is for market penetration, where the company will have to face challenges from competitors and reduction in selling price requires to be done in order to gain competitive advantage.
c) Economy Pricing: The company has expected that the product will become obsolete in 2021, so they need to lower the product price further and sell off every units produced. The company expects to sell only 6000 units of products in the last year with minimum price. This can be attributed to the fact that there may be new designs or improved version of the product in the market and customer preferences have changed. Thus, a lower price is required and entire stock needs to be sold off.
Answer 2:
Target Cost Price per unit
Minimum required margin for the company = 20% of Sales
(Assumption: All year to year calculation are done on Absolute value of Selling Price, thus, the Target Cost Price for every year will be calculated in Absolute terms)
Let the target cost price be X
== > Selling Price  20% of Selling Price = X
== > ( 0.80) of Selling Price = X
The table below provides the target cost price for each yea
Year
Selling Price
Target Cost Price
2019
1,000
800
2020
800
640
2021
750
600
Answer 3:
Total Cost Per Unit for 2019, 2020 and 2021
To calculate Total Cost, Average Cost for Pre and Post sales period needs to be calculated and Average needs to be adjusted during sales period
[Note: No Time Value Money Adjustment has been done this calculation as the Absolute amount cost will be considered for manufacturing as well]
Total estimated cost in year 2018 = $ 5,600,000
Total estimated cost in year 2022 = $ 1,00,000
So, the total cost estimated in these two years = $ ( 5,600,000 + 1,00,000) = $ 5,700,000
Total number of units that is expected to be produced = 12,000 + 17,000 + 6,000 = 35,000 units
Therefore, the average additional cost per unit = 5,700,000 / 35,000 = $ 162.86
Thus,
The Total Cost Per Unit = Total Manufacturing cost per unit + Average Additional Cost Per Unit
The Total Cost per Unit for 2019, 2020 and 2021 are presented below in the table:
Year
Units Produced
Manufacturing Cost per unit
Total Manufacturing cost
Total additional Cost
Total Cost exclusive of Extra Cost
Avg. Extra cost per Unit
Total Extra Cost
Total Costs
Average Cost Per Unit
2,019
12,000
500
6,000,000
1,925,000
7,925,000
163
1,954,286
9,879,286
823
2,020
17,000
500
8,500,000
1,205,000
9,705,000
163
2,768,571
12,473,571
734
2,021
6,000
500
3,000,000
805,000
3,805,000
163
977,143
4,782,143
797
Therefore,
The Total Cost per unit for 2019 = $ 823
The Total Cost per unit for 2020 = $ 734
The Total Cost per unit for 2021 = $ 797
Answer 4:
A comparison of Target cost per unit and Total Cost per unit is provided below
Yea
Target Cost Price
Average Cost Per Unit
2019
800
823
2020
640
734
2021
600
797
It can be seen that the company has a higher average cost per unit than target cost price in the year 2019, 2020 and 2021. This will not allow the company to make required profit margin.
To ensure that a minimum margin of 20% of sales is generated by the company, company should select a target cost price of $ 600 (Minimum of the three years target Cost Price) for all the three years.
a) As suggested earlier, Target cost of $ 625 should be selected in 2018 in order to make a minimum profit margin of 20% in year 2019, 2020 and 2021.
For Target cost price of $ 625, Profit margin for each year is calculated below:
Year
Target Cost Price
Selling Price
Profit Margin
2019
600
1,000
40%
2020
600
800
25%
2021
600
750
20%
It can be seen that the profit Margin for the company is at least 20% of sales in all the three years.
) The method of value engineering should be adopted to meet the required profit margin of at least 20% in all the three years. Value engineering is a systematic methodology to ensure that the required functions are performed at minimum costs. The main focus would be on the marketing costs and service costs that need to be looked into.
c) The method of value engineering has been suggested in 4b, to meet the profit margin of 20% of sales. This can be done by taking systematic approach in analyzing the functions being done by each department and
ing in more efficiency to reduce cost structure. As it can be seen that marketing expense and Supplier training is conducted in 2021 after which the product is bound to get obsolete, so this needs to be eliminated and process needs to be improved to train the supplier in the first three year.
A reduction in marketing expense and training expense by 50 % will be suggested as the extra cost is very high per unit. Moreover, Manufacturing overhead assumed to be 100% of Direct Labour Cost is also at the higher end and is suggested to reduce by 50%.
The Overall impact will be reduced total cost per unit and the company would be in a position to meet the criteria of minimum profit margin.
Calculations with Revised Estimate:
Costs
Direct Material
250
Direct Labou
125
Manufacturing Overhead
50
Total Manufacturing costs
425
Department
2018
2019
2020
2021
2022
Research and Development
1,500,000
Product and Process Design
3,000,000
700,000
Marketing
550,000
400,000
250,000

Supplier training
50,000
87,500
52,500

Customer Support
187,500
450,000
175,000
75,000
Total for each yea
5,100,000
1,375,000
752,500
175,000
75,000
Year
Units Produced
Manufacturing Cost per unit
Total Manufacturing cost
Total additional Cost
Total Cost exclusive of Extra Cost
Avg. Extra cost per Unit
Total Extra Cost
Total Costs
Average Cost Per Unit
2,019
12,000
425
5,100,000
1,375,000
6,475,000
148
1,774,286
8,249,286
687
2,020
17,000
425
7,225,000
752,500
7,977,500
148
2,513,571
10,491,071
617
2,021
6,000
425
2,550,000
175,000
2,725,000
148
887,143
3,612,143
602
Answer 5:
Life cycle budget for Rayhot covering each year from year 2018 to 2022 is depicted below.
a) Using table provided in the case study
) Using Table 1 data and target costs in 4a.
c) NPV of the Project...