Premo Pens, Inc. is in the process of developing a new pen to replace its existing top-of-line Executive Model. Market research has identified the critical features the pen must have and it is estimated that customers would be willing to pay $30 for a pen with these features. Premo's production manager estimates that it will cost $26 to produce the proposed model. The current Executive Model sells for $24 and has a total production cost of $20. A competitor sells a pen similar to the proposed model, but without Premo's patented easy retract feature, for $28. It is estimated to cost the competitor $25 to produce. If Premo seeks to earn a 20% return on sales on the new model, which of the following represents the target cost for the new pen?
A) $26.00.
B) $22.40.
C) $24.00.
D) $19.80.

Question

Quizplus · Accepted Answer

Target cost = Selling price - Desired profit

Premo's desired profit on the new pen is 20% of the selling price, which is $30. Therefore, the desired profit is $6.

Target cost = $30 - $6 = $24

Premo's production cost for the new pen is estimated to be $26, which is more than the target cost. Therefore, Premo may need to find ways to reduce production costs in order to meet the target cost of $24. Option C is the correct answer because it represents the target cost of $24.