Ignite Products is a price-taker. The company produces large spools of electrical wire in a highly competitive market; thus, it uses target pricing. The current market price of the electric wire is $800 per unit. The company has $3,100,000 in average assets, and the desired profit is a return of 7% on assets. Assume all products produced are sold. The company provides the following information: $$\begin{array} { | l | r | l | }
\hline \text { Sales volume } & 100,000 &\text { units per year } \
\hline \text { Variable costs } & \$ 720 & \text { per unit } \
\hline \text { Fixed costs } & \$ 13,000,000& \text { per year } \
\hline
\end{array}$$ If fixed costs cannot be reduced, how much reduction in variable costs will be needed to achieve the desired target?

Question

Ignite Products is a price-taker. The company produces large spools of electrical wire in a highly competitive market; thus, it uses target pricing. The current market price of the electric wire is $800 per unit. The company has $3,100,000 in average assets, and the desired profit is a return of 7% on assets. Assume all products produced are sold. The company provides the following information: $$\begin{array} { | l | r | l | } 
\hline \text { Sales volume } & 100,000 &\text { units per year } \
\hline \text { Variable costs } & \$ 720 & \text { per unit } \
\hline \text { Fixed costs } & \$ 13,000,000& \text { per year } \
\hline
\end{array}$$ If fixed costs cannot be reduced, how much reduction in variable costs will be needed to achieve the desired target?

Quizplus · Accepted Answer

First, calculate the desired profit: 7% of $3,100,000 in assets equals $217,000. The total revenue from selling 100,000 units at $800 each is $80,000,000. To achieve the desired profit, total costs (variable + fixed) must be $80,000,000 (revenue) - $217,000 (desired profit) = $79,783,000. Currently, variable costs are $720 per unit for 100,000 units, totaling $72,000,000, plus fixed costs of $13,000,000, equaling $85,000,000 in total costs. To meet the target, costs must be reduced from $85,000,000 to $79,783,000, a reduction of $5,217,000 in variable costs.

Ignite Products Is a Price-Taker If Fixed Costs Cannot Be Reduced, How Much Reduction in of Electrical