Pan Ltd manufactures a range of specialist furniture for childrens bedrooms. After considerable market research into customer

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Question:

Pan Ltd manufactures a range of specialist furniture for children’s bedrooms. After considerable market research into customer demands Pan Ltd launched a new product, the Wendy-house bed.

Pan Ltd has always followed a pricing policy of cost-plus, based upon total costs, plus a 40% mark-up. As the furniture made by Pan Ltd is hand-made and labour intensive this approach is believed to provide an appropriate level of profit.

One of Pan Ltd’s newly qualified management accountants has approached the board of directors to suggest a new approach that would enable Pan Ltd to achieve profit maximisation. This approach requires an understanding of the demand curve for the product.

Additional market research was therefore carried out to collect the data required to establish a demand curve. The data obtained from this research is as follows: At a market price of £700, annual demand for the Wendy-house bed will be 6,000 beds. When the price is changed to £1,000, annual demand is expected to be 2,000 beds.

Cost information on the Wendy-house bed is:

Variable material per bed £245.00 Variable labour per bed £155.00 Variable overheads per bed £65.00 Fixed overheads related to the Wendy-house bed for the year are expected to be £400,000 based upon 2,500 units of production and sales. The relevant range for this level of fixed costs is up to 8,000 units.

Required:

(a) Calculate the price at which Pan Ltd will sell the ‘Wendy-house bed, based upon the current pricing policy, and the profit expected for the expected sales of 2,500 beds

(b) Using the market research information, and showing all workings, calculate the profit maximising price and demand for the Wendy-house bed and the total profit based on your calculation

(d) Discuss the limitations of long-term pricing.