1. Managers should base pricing decisions on both cost and market factors. In addition, they must also consider legal issues. Describe the influence that the law has on pricing decisions.
Legislation may influence pricing decisions in various ways. The simplest one is the direct influence that involves setting the minimum or maximum retail price for a certain product. For example many governments set a minimum retail price for a pack of cigarettes in order to reduce its consumption and availability to the minors. Maximum price may be set in case when some company occupies a monopoly position on the market. For example in many countries maximum prices for electricity are fixed.
Law may also have an indirect influence on prices. In the majority of cases it works through taxes and tariffs that are imposed for the certain types of goods. For example, an increase in excise taxes for alcohol will drive up prices for spirits. Finally, laws that regulate accounting principles also affect pricing decisions, especially in the financial sector where banks are often obliged to keep a large part of their capital as a reserve.
2. "It is impossible to use Discounted Cash Flow methods for evaluating investments in research and development. There are no cost savings to measure, and we don’t even know what products might come out of our R&D activities." This is a quote from an R&D manager who was asked to justify investment in a major research project based on its expected net present value. How would you respond to this statement? Do you agree or disagree? Explain.
The process of Research and Development carries a lot of uncertainty in terms of projected costs and benefits. However, I believe that proper management may reduce this uncertainty a lot and therefore Discounted Cash Flow may be still applicable for valuation of R&D projects. In fact, if the company clearly understands which projects it tries to develop and has a credible expertise in the field it would be reasonable to expect the outcome of the project to be successful. Moreover, if the company has already completed similar projects it may be able to estimate the projected costs with a good precision.
In the case when the level of uncertainty is still high it might be a good idea to fix maximum possible expenditure for each project which will allow to use DCF to estimate the total costs of R&D projects that may be compared with possible benefits from these projects. Thus, I cannot agree with the manager and believe that DCF is still applicable to R&D projects.
References
Jiambalvo, J. (2003). Managerial accounting. Study guide. New York, Wiley.
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