Estimating Costs and Profits

After preparing the sales forecast, management should analyze expected costs and profits based on estimates prepared by the R&D, manufacturing, marketing, and finance departments. Companies can also use other financial measures to evaluate new-product proposals. The simplest is break-even analysis, in which management estimates how many units of the product the company will have to sell to break even with the given price and cost structure.

The most complex method of estimating profit is risk analysis. Here, three estimates (optimistic, pessimistic, and most likely) are obtained for each uncertain variable affecting profitability under an assumed marketing environment and marketing strategy for the planning period. The computer simulates possible outcomes and computes a rate-of-return probability distribution showing the range of possible rates of returns and their probabilities.10

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