Summer 2007    Vol. 16, No. 3  REAP HOME PAGE  A publication of the Center for Rural Affairs    
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REAP Rural Business Roundtable

Topic: Pricing Your Product Example

Practical Exercise for Calculating the Price of a Product

Setting the correct price for a new product is best not left to guess work or hunches. This month we lead you through an example which REAP Panhandle Business Specialist Jerry Terwilliger created after attending a session on this topic at the Association for Enterprise Opportunity (AEO) conference in Kansas City, Missouri, last May.


Example Business Situation:

Roller Specialties is a specialty small roller manufacturer that re-manufactures hard to find rollers for sale to specialty machinery part retailers. The owner is currently preparing to introduce a new part and needs help pricing it. 

The company has four employees including the owner. All perform direct labor activities. Two employees are paid $9.00/hr, one employee is paid $11.00/hr, and the owner is paid $20.00/hr. The Company averages 111 non-work days per year (365 less weekends - 52 X 2= 104, plus 7-holidays per year). On a typical workday, the employees’ average 6 1/2 hours in production-related activities and the owner averages 3 hours.

The company’s business expenses are projected to be $287,550 for the next 12 months. This includes $69,000 for direct materials and $70,009 for direct labor.

The owner has determined that one batch of rollers will require 4 person-hours of production time and will produce 160 units. Material and packaging will cost $0.73 per unit.

You Will Need this Information:

1. What is the average direct labor wage paid per hour?

                                   Employee 1 - $9.00
                                   Employee 2 -   9.00
                                   Employee 3 - 11.00
                                   Owner -         20.00
                                                       $49.00/ 4 employees = $12.25/hr

2. How many workdays are available to Roller Specialties, assuming there are 365 days in this calendar year?

                                   Calendar days - 365
                            Less non-workdays -111
                  Total workdays available = 254

3. What is the total number of direct labor person-hours projected to be billed during the work year for the owner and employees?

                 Total workdays available    254
                        Scheduled work hours    x   8
        Hours available per employee        2,032
                       Number of employees        x 4
                     Total hours available     8,128
              Less non-billable time *         - 2,413
           Billable direct labor hours =        5,715

*Note: Each employee averages 1 1/2 non-billable hour’s per day (breaks, etc.) x 254 workdays. Owner averages 5 non-billable hours per day x 254 workdays.

                1 1/2 hrs x 254 workdays x 3 employees = 1,143 
                             5 hrs x 254 workdays x 1 owner +1,270
                               Non-billable direct labor hours = 2,413

4. What is the projected overhead dollar expense for the work year? 

                         Business Expenses for 12 months $287,550
                                    Less:
                                    Direct labor                       -$70,009
                                    Direct materials                  -$69,000 
                           Projected overhead expense = $148,541

5. What is the annual overhead percentage for Roller Specialties? 

                Annual overhead expense = Annual overhead percentage
                Annual direct labor cost

                               $148,541 = 2.12 or 212%
                                 $70,009

6. What will one roller cost to produce? 

                          Average direct labor rate     $12.25/person-hr
                          Overhead rate @ 212%   + $25.97 
                          Direct labor cost =              $38.22 1/person-hr

           4 person-hours per batch = 240 minutes/ 160 units per batch = 1.5 minutes per unit

        Direct labor cost/minute ($38.22 / 60 minutes) = $.64 x 1.5 minutes     $0.96
        Direct material costs                                                                         + $0.73 
        Per unit cost for each roller                                                          = $1.69

7. What should the selling price be for each roller if Roller Specialties wants to receive a 25% gross margin on sales? 

               Margin on selling price = $1.69 / .75 = $2.25 established selling price.


Questions about pricing? Contact Jerry Terwilliger, REAP Panhandle Business Specialist at 308.247.9926 or email him at j414@charter.net 


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