How does impact the profitability of the firm

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In the real world, firms are not able to collect precise marginal revenue and cost information. To deal with this problem, firms often adopt what is called cost-plus pricing. In this method, the firm fist estimates the average variable cost (AVC) of producing and selling the product assuming certain "steady state" levels of capacity utilization. The firm then adds to the AVC an average overhead charge so as to get to the estimated fully allocated average cost (AC). To this AC the firm adds a markup (m) to determine the price.

Problem a) Assume that a firm takes 80% of its capacity output of 125 units as the standard output. Further assume that it estimates its TOTAL variable cost and overhead costs to be $1,000 and $600 for the standard output. If the firm targets a markup of 25% on its fully allocated average cost, what is the price at which the firm will sell its output?

Problem b) Now assume that a pandemic strikes the economy and the capacity utilization goes from 80% to 50%. How does this impact the profitability of the firm?

Reference no: EM132647210

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