FORNER CARPET COMPANY
Ms. Ma. Lourdes Salazar
July 13, 2011
Forner Carpet Company, the market leader in high-grade carpet materials, plans to expand/diversify its production, and replace its equipment, hence, a need for fresh capital. In order to support this endeavour, Forner imposed a price increase on its L-42 product to boost income. However, market response has been unsatisfactory, with the competitors acquiring some of Forner’s share.
II. Statement of the Problem
What pricing strategy should Forner Carpet Company utilize in order to maintain the profitability of the L-42 line?
III. Areas of Considerations
The objectives of this case would be:
1. To identify the relevant and irrelevant costs and benefits in a decision; 2. To determine which pricing strategy yields to higher profits; 3. To consider other qualitative factors with regard to pricing strategy, this must be consistent with the expansion plans of the company.
Below are the given data, as stated in the problem:
III. Areas of Considerations
Direct Overhead -
Material Handlers, Suppliers, Repairs, Power, Fringe Benefits
Indirect Overhead -
Supervision, Equipment Depreciation, Heat, and Light
General Overhead -
30% of Direct Labor
Selling and Administrative-
45% of Factory Cost
1. A total of 630,000 square yards of carpet were sold during the first half of 1994 2. 150,000 yards of carpet sold if price $3.95; while 75,000 if price is $4.75 3. The market share of Forner Carpet is not affected by the pricing behavior of the other market players. 4. The study focuses on Forner's L-42 product line and assumes it’s independence from the company’s other products.
1. What was the relationship (if any) between the L-42 pricing decision and the company's future need for capital funds?
The company needed to increase the price of L-42 to avoid a negative contribution margin as affected by the company’s need for large funds for equipment replacements and diversication. If the company retains their old price, these expenditures will absorb the contribution margin until it reaches a negative value. Thus, the increase in price is an anticipation of the company’s upcoming need for a large capital funds.
2. Assuming no other prices are to be considered, should Forner price L-42 at $3.95 or $4.75?
Treating Indirect Cost as Fixed Cost, hence irrelevant, and adjusting Selling and Administrative Expense to reflect only the variable costs:
| |At 75,000 units | |At 150,000 units | |Direct Material |0.52 |21.66% | |0.52 |22.04% | |Material Spoilage |0.051 |2.12% | |0.051 |2.16% | |Direct Labor |0.989 |41.19% | |0.975 |41.33% | |Direct Overhead |0.544 |22.66% | |0.52 |22.04% | |General Overhead |0.297 |12.37% | |0.293 |12.42% | |Factory Cost |2.401 |100.00% | |2.359 |100.00% |
|Adjusted Selling and Admin |At 75,000 |At 150,000 | |45% of Factory Cost |1.08045 |1.06155 | | | | | |
We compute for the following contribution margins:
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