Newcastle Division

Case 3
Newcastle Division
Topic: CVP, Probabilities and Target profits
A meeting of senior managers at the Newcastle Division has been called to discuss the
pricing strategy for a new product. Part of the discussion will focus on the problem of
forecasting sales volume. In the last year a significant number of new products have failed
to achieve their forecast sales volumes. The financial accountant has already stated that
the profit for the year-end will be lower than budget and the main reason for this is the
disappointing sales of new products.
A new technique for estimating the probability of achieving target sales and profits will
be discussed. This requires managers to estimate demand for the new product and assign
probabilities. The management accountant is in favour of this approach as she wants to
avoid having a single estimate for sales.
Details of pricing stategies
The 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 to
reduce costs.
The second strategy is too have a much higher expenditure on advertising and promotions
and set a selling price of £190. With the higher selling price the annual fixed costs would
increase to £27,000,000. The marketing department are very clear that greater expenditure
on advertising and promotions is essential for this product.
The following probability distribution has been agreed with the managers after
consultation and is the same for both selling prices. A wide range of managers from all
departments have agreed to this estimate.
Estimated demand (units)
150,000
160,000
180,000
200,000
210,000

Estimated probability
(units)
0.1
0.4
0.3
0.1
0.1

Estimated standard deviation of sales 18,547 units

Variable costs per unit
The managers estimate that the variable cost per unit is £35.
Target Profits
The target profits identified by the managers are given below. The probability of the new
product only achieving break-even is very important. A profit greater than £4,000,000 is
the 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.
Questions
Question 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 £4,000,000

Question 2
Assuming that the target profit for the new product is £4,000,000 discuss whether your
answer to (1) helps managers choose between the two pricing strategies.

Question 3
Discuss how this techniques can be applied to a large multinational company with a wide
range of products