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Rabu, 13 Mei 2009

pricing - return on investment method

The "return on investment" pricing method determines the price of a product based on the target return on the amount invested in a product:

The calculation is as follows:

Unit Price

Total costs (fixed and variable) + (% return x Investment)

Budgeted sales volume

This calculation can be illustrated using the following example:

Willowbrook Limited has developed a new product called the "Eternal Flame" - a methane-powered heater for use in industrial buildings. Willowbrook requires a return on invested capital of 25% per annum. The sales price for the Eternal Flame should be set using a target return on investment method. The following additional information has been provided:

Budgeted sales volume

25,000 units

Variable production cost per unit

£45

Fixed production cost per unit

£25

Other annual fixed costs (overheads etc.)

£550,000

Investment in new machinery to produce the Eternal Flame

£350,000

Period over which investment in new machinery to be written off

4 years

Research and development costs for the Eternal Flame

£225,000

The total investment in the Eternal Flame is (New machinery + R&D costs)

£575,000

The required annual profit = £575,000 x 25%

£143,750

Total annual costs can be calculated as follows:

Production costs per unit (£45 + £25) x 25,000 units

£1,750,000

Annual depreciation on new machinery (£350,000 / 4)

£87,500

Other annual fixed costs

£550,000

Total annual costs

£2,387,500

Total required annual revenue = total annual costs + required annual profit

£2,531,250

Unit price (total required revenue / budgeted sales volume

£101.25

The use of a targeted return on investment to determine price has the following advantages:

- Consistent with other performance measures - e.g. Return on Investment

- A suitable method for market leaders which are able to set a price which competitors follow

- A relevant pricing method for new products - particularly those which have a substantial investment.

The method does, however, have some disadvantages:

- With new products, there is an inherent uncertainty about what the achieved sales volume will be - which in turn will be influenced by the price chosen

- Some investment may be common to several products or product groups (e.g. an extension to a factory; investment in new development facilities). This raises the question of how to apportion investment amongst products.


http://tutor2u.net/business/marketing/pricing_roi.asp

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