Which of the following best describes the cost-plus pricing approach?
A) Cost base + Markup component = Prospective selling price
B) Prospective selling price + Cost base = Markup component
C) Cost base + Gross margin = Prospective selling price
D) Variable cost + Fixed cost + Contribution margin = Prospective selling price
E) Cost base plus markup ÷ 100% = selling profit percentage
The correct answer and explanation is :
The correct answer is A) Cost base + Markup component = Prospective selling price.
Explanation:
The cost-plus pricing approach is a straightforward and widely used pricing strategy in business. In this method, the company calculates the total cost of producing a product (the “cost base”) and then adds a markup (a percentage of the cost) to determine the final selling price.
Breakdown of the components:
- Cost base: This refers to the total cost of producing a product, which includes both fixed and variable costs (such as materials, labor, overhead, etc.).
- Markup component: This is the amount added to the cost base to determine the selling price. The markup is usually a percentage of the cost base and reflects the desired profit margin for the company.
- Prospective selling price: This is the final price at which the product is sold to customers. It is the sum of the cost base and the markup component.
For example, let’s say a company has a cost base of $50 for producing a product, and they want to add a 20% markup. The markup component would be $50 x 20% = $10, and the prospective selling price would be $50 + $10 = $60.
Why other options are incorrect:
- B) Prospective selling price + Cost base = Markup component: This formula doesn’t align with cost-plus pricing, as it suggests a relationship that doesn’t properly account for the markup.
- C) Cost base + Gross margin = Prospective selling price: Gross margin is a percentage of sales, not a cost-related figure, so it doesn’t fit with cost-plus pricing.
- D) Variable cost + Fixed cost + Contribution margin = Prospective selling price: Contribution margin is a concept related to covering fixed costs, but it isn’t used in cost-plus pricing for setting the selling price.
- E) Cost base plus markup ÷ 100% = selling profit percentage: This is incorrect, as it suggests dividing the cost and markup to get a percentage, which is not how markup is typically calculated.