Meson Production 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: $$\begin{array} { | l | r |r| }
\hline \text { Sales volume } & 100,000 &\text { units per year } \
\hline \text { Variable costs } & \$ 700& \text { per unit } \
\hline \text { Fixed costs } & \$ 12,000,000 &\text { per year } \
\hline
\end{array}$$ If fixed costs cannot be reduced, how much reduction in variable costs will be needed to achieve the profit target?

Question

Meson Production 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: $$\begin{array} { | l | r |r| } 
\hline \text { Sales volume } & 100,000 &\text { units per year } \
\hline \text { Variable costs } & \$ 700& \text { per unit } \
\hline \text { Fixed costs } & \$ 12,000,000 &\text { per year } \
\hline
\end{array}$$ If fixed costs cannot be reduced, how much reduction in variable costs will be needed to achieve the profit target?

Quizplus · Accepted Answer

The profit target is 6% of assets, or $180,000 (0.06 * $3,000,000). The current profit is $800 - $700 = $100 per unit. To achieve the profit target, the variable cost must be reduced by $100 per unit, or $100 * 100,000 units = $10,000,000. The fixed costs cannot be reduced, so the total reduction in costs must be $10,000,000.

Meson Production Is a Price-Taker If Fixed Costs Cannot Be Reduced, How Much Reduction in Electrical