S4PriceSettingAnalysis - Price Setting Assessing the...

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Price Setting Breakeven Analysis: A Primer For those of you unfamiliar with break-even analysis here is a primer. Remember that costs come in two basic forms, variable costs that vary with unit sales and all other costs that do not vary with unit sales and are hence fixed. In the example below, the contribution margin per unit is computed in cell C28 by subtracting the variable costs/unit from the average selling price/unit. If you look in cell C28 the formula is = C26-C27. Please go look. When this difference is negative, the more of the product or service the company sells, the more it loses and bleeds to death. This is not a good economic model, one that never works! The alternative is a positive contribution margin, where each sale contributes to a cash flow that pays for all of the fixed costs and when enough units are sold to recover all of the fixed costs incurred, then each additional unit sold contributes to profit. How many sales do we have to make to recover all of our fixed costs? This sales volume is called break-even, because when we recover all our fixed costs we are breaking-even, an old fashioned term that describes a state of affairs where a firm or a project does not lose money but also does not make any profit. It breaks even. Break-even sales volume is easy to calculate. To work out how many units' contribution margins are needed to pay for all the fixed costs, you divide fixed costs by contribution margin/unit. This is the number of units that need to be sold which, when multiplied by the contribution margin per unit sold, exactly equals fixed costs. The following is a mini-spreadsheet to help you compute break-even volume: Fixed costs $71,000.00 Selling price/unit $0.90 Variable cost/unit $0.60 Contribution margin/unit $0.30 Break-even volume = Fixed Costs/Contribution margin = (C25/C28) = 236,667 Break-even dollar sales = Break-even volume*Price = E30*C26 = $213,000 Now you know why we stressed that you learn which costs are fixed and which costs are variable, and how important it is to measure them. If our fixed cost estimate is good, our variable cost/unit cost is good and our price information is too then we can accurately calculate how much we have to sell to recover the fixed costs involved in the strategy or project. We can then convert that amount into dollar sales and market-share and assess how feasible it is for us to achieve such market-share given the product distribution reach, proposed price and marketing mix campaign. In this way break-even analysis becomes a feasibility analysis. Page 1 of 8 Assessing the feasibility of a price being able to earn the target profit
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But the goal of any project is not to break-even but to earn the target shareholder required rate of return/profit. This needs to be added to fixed costs on the top line. Thus, if we take the above example and add the requirement
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This note was uploaded on 04/11/2011 for the course MRKT 3023 taught by Professor Biritella during the Spring '11 term at FIU.

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S4PriceSettingAnalysis - Price Setting Assessing the...

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