Electron Manufacturing is a price-taker. Electron produces large spools of electrical wire in a highly competitive market; thus, the company uses target pricing. The current market price of the electric wire is $760 per unit. The company has $3,200,000 in average assets, and the desired profit is a return of 5% on assets. Assume all products produced are sold. The company provides the following information: $$\begin{array} { | l | r | r|}
\hline \text { Sales volume } & 110,000 &\text { units per year } \
\hline \text { Variable costs } & \$ 660& \text { per unit } \
\hline \text { Fixed costs } & \$ 12,000,000& \text { per year } \
\hline
\end{array}$$ If variable costs cannot be reduced, how much reduction in fixed costs will be needed to achieve the profit target?

Question

Electron Manufacturing is a price-taker. Electron produces large spools of electrical wire in a highly competitive market; thus, the company uses target pricing. The current market price of the electric wire is $760 per unit. The company has $3,200,000 in average assets, and the desired profit is a return of 5% on assets. Assume all products produced are sold. The company provides the following information: $$\begin{array} { | l | r | r|} 
\hline \text { Sales volume } & 110,000 &\text { units per year } \
\hline \text { Variable costs } & \$ 660& \text { per unit } \
\hline \text { Fixed costs } & \$ 12,000,000& \text { per year } \
\hline
\end{array}$$ If variable costs cannot be reduced, how much reduction in fixed costs will be needed to achieve the profit target?

Quizplus · Accepted Answer

To achieve the desired profit, the company needs to earn $160,000 (5% of $3,200,000). The current contribution margin is $100 per unit ($760 - $660). Total contribution margin is $11,000,000 (110,000 units * $100). To achieve the profit target, the total contribution margin must cover both fixed costs and desired profit. Therefore, fixed costs need to be reduced by $1,160,000 ($12,000,000 - ($11,000,000 - $160,000)).

Electron Manufacturing Is a Price-Taker If Variable Costs Cannot Be Reduced, How Much Reduction in Electrical