Valmont Company has developed a new industrial piece of equipment called the XP-200. The company is considering two methods of establishing a selling price for the XP-200—absorption cost-plus pricing and value-based pricing.

Valmont Company has developed a new industrial piece of equipment called the XP-200. The company is considering two methods of establishing a selling price for the XP-200—absorption cost-plus pricing and value-based pricing.

Valmont’s cost accounting system reports an absorption unit product cost for XP-200 of $10,300. Its markup percentage on absorption cost is 85%. The company’s marketing managers have expressed concerns about the use of absorption cost-plus pricing because it seems to overlook the fact that the XP-200 offers superior performance relative to the comparable piece of equipment sold by Valmont’s primary competitor. More specifically, the XP-200 can be used for 28,000 hours before replacement. It only requires $2,900 of preventive maintenance during its useful life and it consumes $215 of electricity per 1,400 hours used.

These figures compare favorably to the competing piece of equipment that sells for $28,000, needs to be replaced after 14,000 hours of use, requires $5,800 of preventive maintenance during its useful life, and consumes $254 of electricity per 1,400 hours used.

Required:

1. If Valmont uses absorption cost-plus pricing, what price will it establish for the XP-200?

2. What is XP-200’s economic value to the customer (EVC) over its 28,000-hour life?

3. If Valmont uses value-based pricing, what range of possible prices should it consider when setting a price for the XP-200?

Explanation

1.

The absorption cost-plus price of $19,055 is computed as follows:

Unit product cost	$	10,300
Markup (85% × $10,300)		8,755
Selling price per unit	$	19,055

2.

The economic value to the customer (EVC) is computed as follows:

EVC = Reference value + Differentiation value

EVC = $28,000 + $37,480

EVC = $65,480

The differentiation value shown above ($37,480) includes three components. First, customers who purchase an XP-200 rather than the competing alternative would avoid the need to buy a second piece of equipment for $28,000 to achieve 28,000 hours of usage. Second, customers who purchase an XP-200 rather than the competing alternative would realize preventive maintenance savings of $8,700 over a 28,000-hour period, computed as follows:

	Competing Equipment		XP-200
Preventive maintenance cost for 28,000 hours:
$5,800 × (28,000 hours ÷ 14,000 hours)	$	11,600
$2,900 × (28,000 hours ÷ 28,000 hours)			$	2,900
Differentiation value	$8,700

Third, customers who purchase an XP-200 rather than the competing alternative would realize electricity savings of $780 over a 28,000-hour period, computed as follows:

	Competing Equipment		XP-200
Electricity cost for 20,000 hours:
$254 × (28,000 hours ÷ 1,400 hours)	$	5,080
$215 × (28,000 hours ÷ 1,400 hours)			$	4,300
Differentiation value	$780

Thus, the total differentiation value is $28,000 + $8,700 + $780 = $37,480.

3.

The range of possible prices is as follows:

Reference value ≤ Value-based price ≤ EVC

$28,000 ≤ Value-based price ≤ $65,480

Thanks