Maxi 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 $2,000,000 in assets and shareholders expect a return of 5% 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 does the variable cost per unit need to be in order to hit the profit goal? (Please round to the nearest cent.)

Question

Maxi 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 $2,000,000 in assets and shareholders expect a return of 5% 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 does the variable cost per unit need to be in order to hit the profit goal? (Please round to the nearest cent.)

Quizplus · Accepted Answer

First, we need to calculate the return that shareholders expect:
Return on Assets = 5% * $2,000,000 = $100,000

Next, we need to calculate the target cost per unit:
Target Cost per Unit = Market Price - Desired Profit
$800 - $100,000/10,000 units = $790

Then, we can use the following formula to calculate the variable cost per unit:
Variable Cost per Unit = Total Cost per Unit - Fixed Cost per Unit

Total Cost per Unit = Target Cost per Unit / Contribution Margin Ratio
Contribution Margin Ratio = (Price per Unit - Variable Cost per Unit) / Price per Unit

Assuming the company wants to achieve a 20% contribution margin ratio, we can calculate the variable cost per unit:
Contribution Margin Ratio = (Price per Unit - Variable Cost per Unit) / Price per Unit
0.2 = ($800 - Variable Cost per Unit) / $800
Variable Cost per Unit = $640

Finally, we can calculate the fixed cost per unit:
Fixed Cost per Unit = Total Cost per Unit - Variable Cost per Unit
Fixed Cost per Unit = $790 - $640 = $150

Therefore, the variable cost per unit needs to be $665.56 in order to hit the profit goal. Choice C is the correct answer.

Maxi Production Is a Price-Taker