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| Claude Citron Claude Citron (hereafter CC) has manufactured a range of toiletries using the Citron brand for over thirty years. These have mainly been sold through supermarkets. The Citron brand has established a reputation in the lower to mid-market toiletries range for giving good value. The board of CC decided that the company should diversify into perfumes during 20X3 and, after significant investment in research, a new fragrance was developed, 'Potion by Citron'. Initial market research indicated that the fragrance would be popular and could be launched at the beginning of 20X3, but there were different opinions as to how the perfume should be marketed. Thus a board meeting was called. The board meeting The chairman was enthusiastic about the new perfume: 'This is just what the company needs to take up the surplus production capacity that we have been running. I think that, given its popularity, we could sell this product up-market with a high price to signal quality.' The marketing director was a little more cautious: 'Look, let us not get carried away, we need some decent market research first. Even then, we essentially sell basic toiletries. No one is going to buy a high price perfume with a down-market toiletries brand, no matter how good it smells. We need to consider the whole marketing mix.' The finance director argued: 'I agree. I have produced some figures for a price in 20X3, but at this stage they are little more than a guess. In essence the two choices are: Option 1 – to launch 'Potion by Citron' at a low price in order to penetrate the perfume market. This would be implemented by using a cost plus pricing formula of budgeted incremental costs (i.e. relevant cash flows) in 20X3 plus 10%. Option 2 – to have a high price, of $27 per bottle, with heavy advertising and premium packaging to develop an up-market brand image. I would suggest hiring external marketing specialists on a fixed fee contract if we adopt this option.' The finance director's calculations for the expected production and sales of 'Potion by Citron' in 20X3 are as follows:  Notes: (1) Each bottle would take, on average, one hour of labour time to produce, with an extra half hour for the premium packaging under Option 2. Labour is paid $4 per hour but there is an agreement with the union for no redundancies, despite the fact that there are currently 50,000 surplus labour hours each year. (2) Materials and variable overheads include ingredients already in inventory under both options, at $0.50 per bottle. If they were not to be used for 'Potion by Citron' production they would need safe disposal at a cost of $0.10 per bottle. (3) In the finance director's calculations, fixed production overheads are allocated according to the total number of units of output of the company (ie aggregating the number of bottles, sprays, bars of soap etc). The estimated annual fixed production overheads for the company for 20X3,(excluding production of 'Potion by Citron'), was $12,480,000 allocated over 2,400,000 units. With 'Potion by Citron' fixed production overheads would increase to $13,000,000 under Option 1 and to $13,860,000 under Option 2.Required (a) Using the data provided, for each of the two suggested pricing policies (ie Option 1 and Option 2), calculate the expected incremental cash inflows and outflows for 'Potion by Citron' for 20X3. Clearly state any assumptions made. (9 marks) |