Vijay Srirangan, a successful entrepreneur, set up Indipan Industries to manufacture and sell convenience gadgets such as rice cookers, steamers, and tabletop grills to the burgeoning middle class in India. He believed strongly that, with the rise of two-career couples, the demand for these products would skyrocket. He wanted in on the ground floor!
Vijay teamed up with a well-known Japanese firm to set up his plant with the capacity to produce 50,000 rice cookers per month. However, because the product was new to most consumers in the target market, current production is only 20,000 cookers per month.
Vijay?s total materials cost is Indian Rs. 6 million, and labor cost is Rs.9 million. Overhead amounts to an additional Rs.18 million per month. Vijay seeks his accountant?s help in pricing the cooker. The accountant divides the total cost of Rs. 33 million per month into the expected production volume of 20,000 cookers, and determines the cost per cooker to be Rs. 1,650. With a nominal markup of 10%, the accountant recommends pricing the product at Rs. 1,850 per cooker.
Vijay is not happy with this estimate. He believes that he can sell fewer than 7,500 cookers a month if he prices them at Rs. 1,850 each. He had used a price of Rs. 1,400 per cooker when projecting demand at 20,000 cookers a month. He believes that eventually, the consumer will value convenience, and demand will rise to 50,000 cookers per month, as long as the price is less than Rs. 1,500 per cooker.
a. Do you believe that the accountant?s cost estimate accurately reflects the cost to produce each cooker? Why or why not?
b. Vijay?s marketing manager argues that the accountant?s cost estimate is high only because the factory is operating under capacity. She argues that, with full production of 50,000 cookers, the cost per cooker is only Rs. 1,110 (= Rs 300 for materials + Rs. 450 for labor + Rs. 360 for overhead). A 10% markup then leads to a price of about Rs. 1,250 per cooker. Evaluate the merits of this argument.
c. Suppose that Vijay follows his marketing manager?s recommendation and allocates only Rs. 360 (= Rs. 18 million/50,000 cookers) to each cooker. How should Vijay deal with the cost of unused capacity of 30,000 cookers?
This question was answered on: Jul 11, 2017
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