Meson Production is a price-taker. It produces large spools of electrical wire in a highly competitive market, so it practices target pricing. The current market price of the electric wire is $800 per unit. The company has $3,000,000 in assets and its shareholders expect a return of 6% on assets. The company provides the following information: If fixed costs cannot be reduced, how much reduction in variable costs will be needed to achieve the profit target?

Question

Meson Production is a price-taker. It produces large spools of electrical wire in a highly competitive market, so it practices target pricing. The current market price of the electric wire is $800 per unit. The company has $3,000,000 in assets and its shareholders expect a return of 6% on assets. The company provides the following information:  If fixed costs cannot be reduced, how much reduction in variable costs will be needed to achieve the profit target?

Quizplus · Accepted Answer

To calculate the reduction in variable costs needed to achieve the profit target, we need to first calculate the required profit. 
Return on Assets = 6% of $3,000,000 = $180,000 
Profit = Assets x Return on Assets = $3,000,000 x 6% = $180,000

The target price is $800 per unit, and the company practices target pricing, so the company's profit margin should be $800 - variable cost per unit.

Therefore, we can calculate the required reduction in variable costs per unit as follows: 
$800 - Variable cost per unit = $180,000 / Total units produced 
Variable cost per unit = $800 - ($180,000 / Total units produced)

Assuming the company sells 10,000 units: 
Variable cost per unit = $800 - ($180,000 / 10,000) 
Variable cost per unit = $800 - $18 
Variable cost per unit = $782

To achieve the target profit, Meson Production needs to reduce variable costs per unit to $782. Therefore, the reduction in variable costs needed to achieve the profit target is $800 - $782 = $18 per unit. 
Total reduction in variable costs needed = $18 x 10,000 units = $180,000 per year 
Thus, option C is the correct answer.

Meson Production Is a Price-Taker