ICAEW BIP · Chapter 4
Pricing decisions MCQs with Answers
11 multiple-choice questions on Pricing decisions for ICAEW BIP Business Insight and Performance. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
A product sells for £150, which gives a profit margin of 20% on the selling price. What is the equivalent mark-up on cost?
- A) 16%
- B) 30%
- C) 25%
- D) 20%
Show answer & explanation
Answer: C) 25%
Cost = £150 x (1 - 0.20) = £120, so profit = £30. Mark-up on cost = £30 / £120 = 25%. A margin is always a smaller percentage than the equivalent mark-up because it is measured on the larger selling price.
Question 2
The full cost of a product is £64 per unit. The company sets prices using a mark-up of 25% on full cost. What is the selling price?
- A) £85.33
- B) £80.00
- C) £72.00
- D) £16.00
Show answer & explanation
Answer: B) £80.00
A mark-up is a percentage of cost. Selling price = £64 x 1.25 = £80.00. £85.33 would be the price if 25% were a margin on selling price.
Question 3
A company uses marginal cost-plus pricing with a mark-up of 60%. The variable cost of a product is £36 per unit and the fixed cost per unit, based on budgeted output, is £14. What is the selling price?
- A) £80.00
- B) £57.60
- C) £90.00
- D) £71.60
Show answer & explanation
Answer: B) £57.60
Marginal cost-plus pricing adds the mark-up to variable (marginal) cost only. Price = £36 x 1.60 = £57.60. The mark-up has to be large enough to cover fixed costs and give a profit, which is why it is higher than a typical full cost mark-up.
Question 4
Lynton Ltd is developing a new product. Market research shows a competitive selling price of £220. The company requires a profit margin of 30% of selling price. The current estimated cost of the product is £171. What is the cost gap that must be closed?
- A) £17.00
- B) £1.77
- C) £66.00
- D) £49.00
Show answer & explanation
Answer: A) £17.00
Target cost = target price less required profit = £220 x (1 - 0.30) = £154.00. Cost gap = estimated cost £171 - target cost £154.00 = £17.00. Lynton must find ways to reduce cost, for example through value engineering, before the product goes into production.
Question 5
When a company raised the price of a product from £20 to £22, monthly demand fell from 5,000 units to 4,400 units. Using the original price and quantity as the base, what is the price elasticity of demand and how is demand described?
- A) -1.2: demand is inelastic
- B) -0.83: demand is elastic
- C) -1.2: demand is elastic
- D) -0.83: demand is inelastic
Show answer & explanation
Answer: C) -1.2: demand is elastic
Percentage change in quantity = (4,400 - 5,000) / 5,000 = -12%. Percentage change in price = (£22 - £20) / £20 = +10%. PED = -12% / 10% = -1.2. Ignoring the sign, the value is greater than 1, so demand is elastic and the price rise reduces total revenue.
Question 6
A company estimates monthly demand for a product at different prices as follows: £30: 12,000 units £32: 10,800 units £34: 9,500 units £36: 8,200 units Variable cost is £18 per unit and fixed costs will not change. Which price should be set to maximise profit?
- A) £36
- B) £32
- C) £30
- D) £34
Show answer & explanation
Answer: D) £34
Because fixed costs do not change, profit is maximised at the price that gives the highest total contribution. £30: (£30 - £18) x 12,000 = £144,000; £32: (£32 - £18) x 10,800 = £151,200; £34: (£34 - £18) x 9,500 = £152,000; £36: (£36 - £18) x 8,200 = £147,600. The highest contribution is at £34. Choosing the price with the highest revenue (£30) ignores variable costs.
Question 7
A company launches a new product at a deliberately low price to win market share quickly and discourage competitors from entering. What is this pricing strategy called?
- A) Price discrimination
- B) Market skimming
- C) Premium pricing
- D) Penetration pricing
Show answer & explanation
Answer: D) Penetration pricing
Penetration pricing sets a low initial price to gain a large share of the market quickly, achieve economies of scale and create a barrier to entry. Market skimming is the opposite: a high launch price aimed at customers willing to pay a premium, which is later reduced.
Question 8
In which of the following situations would market skimming be most appropriate for a new product?
- A) Competitors can copy the product quickly and cheaply
- B) The product is innovative, has no close substitutes and early buyers will pay a high price for it
- C) The company needs high volumes immediately to achieve economies of scale
- D) Demand for the product is highly price elastic
Show answer & explanation
Answer: B) The product is innovative, has no close substitutes and early buyers will pay a high price for it
Skimming charges a high launch price to customers who value novelty, then lowers the price over time. It works best when the product is new and different, demand from early buyers is relatively inelastic and barriers to entry protect the high price. High price elasticity, easy imitation or a need for volume all favour penetration pricing.
Question 9
Fenwick Ltd expects to sell 20,000 units of a product a year. The full cost is £45 per unit. The capital employed in making the product is £1,200,000, and the company requires an annual return of 15% on capital employed. What selling price per unit is needed to achieve the required return?
- A) £54.00
- B) £51.75
- C) £105.00
- D) £52.65
Show answer & explanation
Answer: A) £54.00
Required annual profit = £1,200,000 x 15% = £180,000. Required profit per unit = £180,000 / 20,000 = £9.00. Selling price = full cost £45 + £9.00 = £54.00. Applying a 15% mark-up to cost confuses return on capital with return on cost.
Question 10
Which of the following is a weakness of full cost-plus pricing?
- A) It cannot be applied to services
- B) It is difficult to calculate because it needs detailed demand data
- C) It ignores the effect of price on demand and competitors' prices
- D) It never covers fixed costs
Show answer & explanation
Answer: C) It ignores the effect of price on demand and competitors' prices
Cost-plus pricing is simple and, if budgeted volumes are achieved, makes sure all costs are covered. Its main weakness is that it looks only inward at cost, ignoring customers' willingness to pay and competitors' prices. It is widely used for services and needs no demand data, which is part of why it is popular.
Question 11
A product requires £22 of direct materials and 3 direct labour hours paid at £14 per hour. Production overheads are absorbed at £18 per direct labour hour. Administration overheads are added at 10% of total production cost. The selling price is set to give a profit margin of 20% of the selling price. What is the selling price (to the nearest penny)?
- A) £147.50
- B) £155.76
- C) £112.75
- D) £162.25
Show answer & explanation
Answer: D) £162.25
Production cost = £22 + (3 x £14) + (3 x £18) = £22 + £42 + £54 = £118.00. Total cost = £118.00 x 1.10 = £129.80. Profit is 20% of price, so cost is 80% of price. Price = £129.80 / 0.80 = £162.25.