Kerr Productions 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 is $800 per unit. The company has $3,000,000 in average assets, and the desired profit is a return of 8% on assets. Assume all products produced are sold. The company provides the following information: $$\begin{array} { | l | r | l | }
\hline \text { Sales volume } & 100,000& \text { units per year } \
\hline \text { Variable costs } & \$ 725 & \text { per unit } \
\hline \text { Fixed costs } & \$ 14,000,000& \text { per year } \
\hline
\end{array}$$ 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 achieve the desired target? (Round your answer to the nearest cent.)

Question

Kerr Productions 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 is $800 per unit. The company has $3,000,000 in average assets, and the desired profit is a return of 8% on assets. Assume all products produced are sold. The company provides the following information: $$\begin{array} { | l | r | l | } 
\hline \text { Sales volume } & 100,000& \text { units per year } \
\hline \text { Variable costs } & \$ 725 & \text { per unit } \
\hline \text { Fixed costs } & \$ 14,000,000& \text { per year } \
\hline
\end{array}$$ 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 achieve the desired target? (Round your answer to the nearest cent.)

Quizplus · Accepted Answer

The desired profit is 8% of $3,000,000, which is $240,000. The total revenue from selling 100,000 units at $800 each is $80,000,000. To achieve the desired profit, total costs must be $80,000,000 - $240,000 = $79,760,000. With fixed costs at $14,000,000, the total variable cost allowed is $79,760,000 - $14,000,000 = $65,760,000. The variable cost per unit must then be $65,760,000 / 100,000 units = $657.60. The current variable cost is $725 per unit, so the reduction needed is $725 - $657.60 = $67.40.

Kerr Productions Is a Price-Taker Currently the Cost Structure Is Such That the Company Cannot