Meson Production is a price-taker. They produce large spools of electrical wire in a highly competitive market, and so they practice target pricing. The current market price is $800 per unit. The company has $3,000,000 in assets and shareholders expect a return of 6% on assets. The company provides the following information: $$\begin{array} { | l | r | l | }
\hline \text { Sales volume } & 100,000 & \text { units per year } \
\hline \text { Variable costs } & \$ 700 & \text { per unit } \
\hline \text { Fixed costs } & \$ 12,000,000 & \text { per year } \
\hline
\end{array}$$ Currently the cost structure is such that the company cannot achieve its profit objective and must cut costs. If fixed costs cannot be reduced, how much reduction in variable cost per unit will be needed to hit the profit target?

Question

Meson Production is a price-taker. They produce large spools of electrical wire in a highly competitive market, and so they practice target pricing. The current market price is $800 per unit. The company has $3,000,000 in assets and shareholders expect a return of 6% on assets. The company provides the following information: $$\begin{array} { | l | r | l | } 
\hline \text { Sales volume } & 100,000 & \text { units per year } \
\hline \text { Variable costs } & \$ 700 & \text { per unit } \
\hline \text { Fixed costs } & \$ 12,000,000 & \text { per year } \
\hline
\end{array}$$ Currently the cost structure is such that the company cannot achieve its profit objective and must cut costs. If fixed costs cannot be reduced, how much reduction in variable cost per unit will be needed to hit the profit target?

Quizplus · Accepted Answer

First, calculate the target profit using the formula:
Target profit = Assets x Target Return on Assets
Target profit = $3,000,000 x 6% = $180,000

Next, calculate the target cost per unit using the formula:
Target cost per unit = Market price - Target profit
Target cost per unit = $800 - $180 = $620

Then, calculate the total cost per unit using the formula:
Total cost per unit = Variable cost per unit + (Fixed cost / Sales volume)
Total cost per unit = $700 + ($12,000,000 / 100,000) = $820

Finally, calculate the required reduction in variable cost per unit using the formula:
Reduction in variable cost per unit = Total cost per unit - Target cost per unit
Reduction in variable cost per unit = $820 - $620 = $200
Therefore, the required reduction in variable cost per unit is $200, which is equivalent to $21.80 per unit (since there are 9,091 units produced per $200 reduction). Thus, the correct answer is D.

Meson Production Is a Price-Taker Currently the Cost Structure Is Such That the Company Cannot