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: 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:  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

To solve this problem, we need to use the target pricing formula: 
Target Price = Total Cost + Desired Profit

We know that the current market price is $800 per unit, and shareholders expect a return of 6% on assets, which is $180,000 ($3,000,000 x 6%).

We also know that the cost structure is such that the company cannot achieve its profit objective, so we need to find out how much reduction in variable cost per unit is needed to hit the profit target.

Let's assume that the fixed cost per unit is $400 (we can find this by subtracting the variable cost per unit from the total cost per unit at the current market price of $800).

So, we can write: 
$800 = $400 + Variable Cost per Unit + $180,000

Simplifying this equation: 
Variable Cost per Unit = $220

Therefore, we need to reduce the variable cost per unit by $220 - $198.20 = $21.80 to hit the profit target.

So, the correct answer is D, reduction in variable cost per unit by $21.80.

Meson Production Is a Price-Taker