Meson Production is a price-taker. They produce large spools of electrical wire in a highly competitive market, and so they practice target pricing. The current market price is $800 per unit. The company has $3,000,000 in assets and shareholders expect a return of 6% on assets. The company provides the following information: $$\begin{array} { | l | r |r| }
\hline \text { Sales volume } & 100,000 &\text { units per year } \
\hline \text { Variable costs } & \$ 700& \text { per unit } \
\hline \text { Fixed costs } & \$ 12,000,000 &\text { per year } \
\hline
\end{array}$$ 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 hit the profit target?

Question

Meson Production is a price-taker. They produce large spools of electrical wire in a highly competitive market, and so they practice target pricing. The current market price is $800 per unit. The company has $3,000,000 in assets and shareholders expect a return of 6% on assets. The company provides the following information: $$\begin{array} { | l | r |r| } 
\hline \text { Sales volume } & 100,000 &\text { units per year } \
\hline \text { Variable costs } & \$ 700& \text { per unit } \
\hline \text { Fixed costs } & \$ 12,000,000 &\text { per year } \
\hline
\end{array}$$ 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 hit the profit target?

Quizplus · Accepted Answer

The profit target is 6% of $3,000,000, which is $180,000. To achieve this, the total profit must be $180,000. The current profit is calculated as (Sales price - Variable cost) * Sales volume - Fixed costs = ($800 - $700) * 100,000 - $12,000,000 = -$2,000,000. To achieve a profit of $180,000, the profit needs to increase by $2,180,000. This requires a reduction in variable costs of $21.80 per unit.

Meson Production Is a Price-Taker Currently the Cost Structure Is Such That the Company Cannot