(a) What is Variance Analysis ? What are the possible reasons for different Cost Variances ? 15 marks (b) Explain in brief the…

(a) Variance analysis and the reasons for cost variances

Variance analysis compares actual results with standard or budgeted figures, identifies the difference (variance), finds its causes and fixes responsibility, enabling management by exception. A variance is favourable if it raises profit and adverse if it lowers it.

Cost variances and possible reasons:

Material: price variance, from market price changes, bulk discounts, poor purchase planning or inflation; usage variance, from wastage, pilferage, poor quality or machine settings; mix and yield variances from changes in material proportions.

Labour: rate variance, from wage hikes or use of different grades; efficiency variance, from skill, supervision, poor materials or tools; idle time variance, from breakdowns, power failure or shortages; mix variance from different grades of workers.

Overhead: variable overhead expenditure variance, from price changes in indirect inputs; efficiency variance, from labour or machine hours; fixed overhead expenditure variance, from changes in spending; volume variance, from capacity use, calendar and efficiency.

Not all causes are controllable: faulty standards or external price changes should be revised, not blamed on managers.

(b) Valuation approaches for venture capital investments

The conventional (venture capital) method estimates the firm's exit value at the end of the holding period, typically year 5, by applying an industry P/E multiple to projected earnings. This terminal value is discounted at the investor's high required return (often 30–60%) to give the present or post-money value. The investor's required ownership equals the investment divided by that value, adjusted for expected dilution from later rounds. It is simple but ignores risk of failure beyond the high discount rate.

The First Chicago method values the firm under three scenarios: success, sideways or survival, and failure, each with its own cash flows, exit value and probability. Each is discounted and the expected value is the probability-weighted sum. It captures downside risk, but probabilities are subjective.

The revenue multiplier method values the firm at exit as projected revenue times an industry revenue multiple, as comparable firms are valued, then discounts at the required return. It suits firms with negative or no earnings, but ignores margins and profitability.

(c)(i) 'Cost determines price' is a myth

I largely agree. Cost sets the floor below which the firm loses money, but price is set by customer-perceived value, demand, competition and positioning. Apple prices phones far above manufacturing cost because buyers value the brand and ecosystem. Airlines charge different fares for identical seats at nearly identical cost, depending on demand and booking time. Luxury brands set high prices to signal prestige. Conversely, cost-plus pricing can fail: a product priced from its cost in a competitive market may be overpriced or underpriced.

Target costing reverses the logic: the market price minus target margin gives the allowable cost. So cost informs profitability and viability, but value, competition and demand determine price.

(c)(ii) Pricing strategies and a luxury cosmetic

Types: cost-based pricing (cost-plus, mark-up, target return, break-even); competition-based pricing (going-rate, sealed bid); value-based pricing (perceived value, skimming, penetration, prestige and psychological pricing); product-mix pricing (product-line, bundling, captive, optional); promotional pricing (discounts, loss leaders); and dynamic pricing.

For a new luxury cosmetic aimed at premium customers, I would recommend prestige pricing with skimming, a high launch price with premium packaging, limited distribution through high-end stores and selected online channels, and an assured quality story with influencers. Price-quality perception is strong in luxury, so low prices would harm positioning. Use product-line pricing, such as a premium flagship serum and entry-level products, and later reduce price or extend lines after recovering development costs and when competition arrives.