Question

Lovell Computer Parts Inc. is in the process of setting a selling price on a new component it has just designed and developed. The following cost estimates for this new component have been provided by the accounting department for a budgeted volume of 45,000 units.

		Per Unit				Total
Direct materials			$51
Direct labor			$30
Variable manufacturing overhead			$20
Fixed manufacturing overhead						$495,000
Variable selling and administrative expenses			$18
Fixed selling and administrative expenses						$225,000

Lovell Computer Parts management requests that the total cost per unit be used in cost-plus pricing its products. On this particular product, management also directs that the target price be set to provide a 18% return on investment (ROI) on invested assets of $1,000,000.

A.) Compute the markup percentage and target selling price that will allow Lovell Computer Parts to earn its desired ROI of 18% on this new component.

B.) Assuming that the volume is 36,000 units, compute the markup percentage and target selling price that will allow Lovell Computer Parts to earn its desired ROI of 18% on this new component.

Answer 1

a). Variable Costs:
Direct material = $51
Direct labor = $30
Variable manufacturing overhead = $20
Variable selling and administrative expenses = $18
Total variable cost per unit = $119

Total variable cost for 45000 units = 45000 * $119 = $5,355,000
Total fixed costs = $495000 + $225000 = $720,000
Total cost = $6,075,000

ROI required = $1,000,000 * 18% = $180,000

Markup percentage = $180,000 / $6,075,000 = 0.0296 or 2.96%
Target sales = Total cost + Target profit = $6,075,000 + $180,000 = $6,255,000
Target selling price = $6,255,000 / 45000 = $139 per unit

b). If volume is 36000 units.

Total variable cost for 36000 units = 36000 * $119 = $4,284,000
Total fixed costs = $495000 + $225000 = $720,000
Total cost = $5,004,000

ROI required = $1,000,000 * 18% = $180,000

Markup percentage = $180,000 / $5,004,000 = 0.036 or 3.60%
Target sales = Total cost + Target profit = $5,004,000 + $180,000 = $5,184,000
Target selling price = $5,184,000 / 36000 = $144 per unit