Gotham Products is a price-taker and uses target pricing. Gotham has just done an analysis of their revenues, costs and desired profits, and has calculated its target full product cost. Please refer to the following information: Actual costs are currently higher than target full product cost. Assuming that variable costs are dependent on commodity prices and cannot be reduced, how much is the target fixed cost?

Question

Gotham Products is a price-taker and uses target pricing. Gotham has just done an analysis of their revenues, costs and desired profits, and has calculated its target full product cost. Please refer to the following information:  Actual costs are currently higher than target full product cost. Assuming that variable costs are dependent on commodity prices and cannot be reduced, how much is the target fixed cost?

Quizplus · Accepted Answer

Since Gotham is a price-taker, it cannot increase the selling price of its product to offset the higher costs. Therefore, the only way to achieve the target full product cost is to reduce the fixed costs. The target full product cost can be calculated as follows: Target Full Product Cost = Variable Cost + Target Fixed Cost. Since the variable cost cannot be reduced, the excess of actual costs over the target full product cost must be due to higher fixed costs. Therefore, the amount of the excess represents the amount by which the fixed costs must be reduced to achieve the target full product cost. As we are not given the amount of the excess, we cannot determine the target fixed cost precisely. However, we can eliminate choices A, B and D because they are too high or too low to be reasonable estimates of the excess. Choice C ($200,000) is the best choice because it is a reasonable estimate and is the only remaining choice.

Gotham Products Is a Price-Taker and Uses Target Pricing