Meson Productions 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 Productions 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 achieve the target profit, we need to calculate the total assets required to achieve the desired 6% return.

Total assets required = Profit before tax / Rate of return on assets 
                    = (3,000,000 x 6%) / (100% - 6%)
                    = $327,272.73
                     
Next, we need to calculate the target cost per unit:
Target cost = Market price - Desired profit margin 
            = $800 - (6% x $327,272.73)
            = $781.82
            
Now, we can calculate the variable cost per unit:
Variable cost per unit = Total cost per unit - Fixed cost per unit
                       = $781.82 - ($5,000,000 / 12,500)
                       = $400.00
                        
Finally, we can calculate the reduction in variable cost per unit that is required to achieve the target profit:

Reduction in variable cost per unit = Current variable cost per unit - Target variable cost per unit
                                   = $500.00 - $400.00
                                   = $100.00
                            
Total reduction in variable costs = Reduction in variable cost per unit x Units sold
                                 = $100.00 x 21,000
                                 = $2,100,000.00
                                 
Therefore, the option C) $2,180,000 is the right answer.

Meson Productions Is a Price-Taker