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Newcastle Division




Question;Case 3Newcastle DivisionTopic: CVP, Probabilities and Target profitsA meeting of senior managers at the Newcastle Division has been called to discuss thepricing strategy for a new product. Part of the discussion will focus on the problem offorecasting sales volume. In the last year a significant number of new products have failedto achieve their forecast sales volumes. The financial accountant has already stated thatthe profit for the year-end will be lower than budget and the main reason for this is thedisappointing sales of new products.A new technique for estimating the probability of achieving target sales and profits willbe discussed. This requires managers to estimate demand for the new product and assignprobabilities. The management accountant is in favour of this approach as she wants toavoid having a single estimate for sales.Details of pricing stategiesThe first strategy is to set a selling price of ?170 with annual fixed costs at ?22,000,000.A number of managers are in favour of this strategy as they believe it is important toreduce costs.The second strategy is too have a much higher expenditure on advertising and promotionsand set a selling price of ?190. With the higher selling price the annual fixed costs wouldincrease to ?27,000,000. The marketing department are very clear that greater expenditureon advertising and promotions is essential for this product.The following probability distribution has been agreed with the managers afterconsultation and is the same for both selling prices. A wide range of managers from alldepartments have agreed to this estimate.Estimated demand (units)150,000160,000180,000200,000210,000Estimated probability(units) standard deviation of sales 18,547 unitsVariable costs per unitThe managers estimate that the variable cost per unit is ?35.Target ProfitsThe target profits identified by the managers are given below. The probability of the newproduct only achieving break-even is very important. A profit greater than ?4,000,000 isthe required return for the new product. If the product cannot achieve a profit greater than?4,000,000 it is very unlikely that managers will accept it.QuestionsQuestion 1(a)For both pricing strategies calculate the probability of:(i)A profit greater than ?1,500,000(ii)A profit of ?0 (break-even)(iii)A profit greater than ?4,000,000Question 2Assuming that the target profit for the new product is ?4,000,000 discuss whether youranswer to (1) helps managers choose between the two pricing strategies.Question 3Discuss how this techniques can be applied to a large multinational company with a widerange of products


Paper#50177 | Written in 18-Jul-2015

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