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Just over two years ago, RB Co was the first company to produce a specific 'off-the-shelf' accounting software package. The pricing strategy, decided on by the managing director, for the packages was to add a 50% mark-up to the budgeted full cost of the packages. The company achieved and maintained a significant market share and high profits for the first two years. Budgeted information for the current year (Year 3) was as follows.

Production and sales 15,000 packages

Full cost $400 per package

At a recent board meeting, the finance director reported that although costs were in line with the budget for the current year, profits were declining. He explained that the full cost included $80 for fixed overheads. This figure had been calculated by using an overhead absorption rate based on labour hours and the budgeted level of production of 15,000 packages. He pointed out that this was much lower than the current capacity of 25,000 packages. The marketing director stated that competitors were beginning to increase their market share. He also reported the results of a recent competitor analysis which showed that when RB Co announced its prices for the current year, the competitors responded by undercutting them by 15%. Consequently, he commissioned an investigation of the market. He informed the board that the market research showed that at a price of $750 there would be no demand for the packages but for every $10 reduction in price the demand would increase by 1,000 packages. The managing director appeared to be unconcerned about the loss of market share and argued that profits could be restored to their former level by increasing the mark-up.

Requirements:                                                                                                          (Total = 20 marks)

(a) Discuss the managing director's pricing strategy in the circumstances described above. (5 marks)
(b) Suggest and explain two alternative strategies that could have been implemented at the launch of the packages. (4 marks)
(c) Based on the data supplied by the market research, derive a straight line demand equation for the packages. (3 marks)
(d) RB's total costs (TC) can be modelled by the equation TC = 1,200,000 + 320Q. Explain the meaning of this equation. (3 marks)
(e) Explain what is meant by price elasticity of demand and explain the implications of elasticity for RB's pricing strategy. (5 marks)

                                                                                                                                                                                           

Requirements:

a

 Discuss the managing director's pricing strategy in the circumstances described above.

Marks: 5
b

Suggest and explain two alternative strategies that could have been implemented at the launch of the packages. (4 marks)

Marks: 4
c

Based on the data supplied by the market research, derive a straight line demand equation for the packages. (3 marks)

Marks: 3
d

RB's total costs (TC) can be modelled by the equation TC = 1,200,000 + 320Q. Explain the meaning of this equation. (3 marks)

Marks: 3
e

 Explain what is meant by price elasticity of demand and explain the implications of elasticity for RB's pricing strategy. (5 marks)

Marks: 5