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describe briefly how computer assistance might improve the analysis 597763

Pricing decision and the calculation of expected profit and margin of safety

E Ltd manufactures a hedge-trimming device which has been sold at £16 per unit for a number of years. The selling price is to be reviewed and the following information is available on costs and likely demand.

The standard variable cost of manufacture is £10 per unit and an analysis of the cost variances for the past 20 months show the following pattern which the production manager expects to continue in the future.

Adverse variances of +10% of standard variable cost occurred in ten of the months.

Nil variances occurred in six of the months. Favourable variances of 5% of standard variable cost occurred in four of the months.

Monthly data

Fixed costs have been £4 per unit on an average sales level of 20 000 units but these costs are expected to rise in the future and the following estimates have been made for the total fixed cost:


Optimistic estimate (Probability 0.3)

82 000

Most likely estimate (Probability 0.5)

85 000

Pessimistic estimate (Probability 0.2)

90 000

The demand estimates at the two new selling prices being considered are as follows:

If the selling

price/unit is



demand would be:

Optimistic estimate

21 000 units

19 000 units

(Probability 0.2)

Most likely estimate

19000 units

17500 units

(Probability 0.5)

Pessimistic estimate

16500 units

15500 units

(Probability 0.3)

It can be assumed that all estimates and probabil­ities are independent.

You are required to

(a) advise management, based only on the infor­mation given above, whether they should alter the selling price and, if so, the price you would recommend;

(b) calculate the expected profit at the price you recommend and the resulting margin of safety, expressed as a percentage of expected sales;

(c) criticise the method of analysis you have used to deal with the probabilities given in the question;

(d) describe briefly how computer assistance might improve the analysis.

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