Minden Corporation estimates that the following costs and activity would be associated with the manufacture and sale of product A: If the company uses the absorption costing approach to cost-plus pricing described in the text and desires a 11% rate of return on investment (ROI), the required markup on absorption cost for Product A would be closest to:
A) 28%
B) 7%
C) 11%
D) 45%

Question

Minden Corporation estimates that the following costs and activity would be associated with the manufacture and sale of product A:  If the company uses the absorption costing approach to cost-plus pricing described in the text and desires a 11% rate of return on investment (ROI), the required markup on absorption cost for Product A would be closest to:
A) 28% 
B) 7% 
C) 11% 
D) 45%

Quizplus · Accepted Answer

To calculate the required markup on absorption cost, we need to first determine the total absorption cost per unit:

Direct materials + Direct labor + Variable manufacturing overhead + Fixed manufacturing overhead
= $18 + $10 + ($1.50 × 4) + ($8 × 2)
= $49 per unit

With a desired ROI of 11%, we can calculate the required markup as follows:

Required markup = ROI ÷ Investment turnover
where investment turnover = 1 ÷ (percentage of investment in sales)

Assuming that the investment in sales is 80% (which means that 80% of sales revenue is used to cover the company's total costs), we can calculate the required markup as:

Required markup = 0.11 ÷ (1 ÷ 0.8)
= 0.11 ÷ 1.25
= 0.088 or 8.8%

Finally, we can convert the required markup on total cost to a markup on absorption cost using the formula:

Markup on absorption cost = Markup on total cost ÷ (1 + (Total fixed manufacturing overhead ÷ Total direct labor cost))

= 0.088 ÷ (1 + ($8 × 2 ÷ $10))
= 0.088 ÷ 1.6
= 0.055 or 5.5%

Therefore, the required markup on absorption cost for Product A would be closest to 45%.

Minden Corporation Estimates That the Following Costs and Activity Would