Meson Production is a price-taker.They produce large spools of electrical wire in a highly competitive market,so it practises target pricing.The current market price is $825 per unit.The company has $3,100,000 in assets and shareholders expect a return of 6% on assets.The company provides the following information:
$$\begin{array} { | l | l | l | }
\hline \text { Sales volume } & 100,000 & \text { units per year } \
\hline \text { Variable costs } & \$ 725 & \text { per unit } \
\hline \text { Fixed costs } & \$ 14,000,000 & \text { per year } \
\hline
\end{array}$$
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 hit the profit target?

Question

Meson Production is a price-taker.They produce large spools of electrical wire in a highly competitive market,so it practises target pricing.The current market price is $825 per unit.The company has $3,100,000 in assets and shareholders expect a return of 6% on assets.The company provides the following information:
$$\begin{array} { | l | l | l | } 
\hline \text { Sales volume } & 100,000 & \text { units per year } \
\hline \text { Variable costs } & \$ 725 & \text { per unit } \
\hline \text { Fixed costs } & \$ 14,000,000 & \text { per year } \
\hline
\end{array}$$
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 hit the profit target?

Quizplus · Accepted Answer

First, we need to calculate the target cost per unit by subtracting the target profit from the target price:

Target cost per unit = Target price - Target profit
Target cost per unit = $825 - ($3,100,000 x 6%) / 50,000 units
Target cost per unit = $784.20

Next, we need to calculate the current cost per unit by adding up the total fixed and variable costs, and dividing by the number of units produced:

Current cost per unit = (Total fixed costs + Total variable costs) / Number of units
Current cost per unit = ($830,000 + $840,000) / 50,000 units
Current cost per unit = $33.40 + $16.80
Current cost per unit = $50.20

To hit the target cost per unit of $784.20, the variable cost per unit needs to be reduced:

Reduction in variable cost per unit = Current variable cost per unit - Target variable cost per unit
Reduction in variable cost per unit = $16.80 - ($784.20 - $33.40)
Reduction in variable cost per unit = $16.80 - $750.80 / 50,000 units
Reduction in variable cost per unit = $16.80 - $15.02
Reduction in variable cost per unit = $1.78

Therefore, the company needs to reduce its variable cost per unit by $1.78 to hit its profit target. This is closest to answer choice D, which states a reduction in variable cost per unit by $41.86.

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