Question

Wilderness Products, Inc., has designed a self-inflating sleeping pad for use by backpackers and campers. The following information is available about the new product: An investment of $1,900,000 will be necessary to carry inventories and accounts receivable and to purchase some new equipment needed in the manufacturing process. The company’s required rate of return is 26% on all investments. A standard cost card has been prepared for the sleeping pad, as shown below: Standard Quantity or Hours Standard Price or Rate Standard Cost Direct materials 5 yards $ 3.80 per yard $ 19.00 Direct labor 3 hours $ 9.00 per hour 27.00 Manufacturing overhead (20% variable) 3 hours $ 13.00 per hour 39.00 Total standard cost per pad $ 85.00 The only variable selling and administrative expense will be a sales commission of $9 per pad. The fixed selling and administrative expenses will be $2,761,000 per year. Because the company manufactures many products, no more than 105,000 direct labor-hours per year can be devoted to production of the new sleeping pads. Manufacturing overhead costs are allocated to products on the basis of direct labor-hours. Required: 1. Assume that the company uses the absorption approach to cost-plus pricing. a. Compute the markup percentage that the company needs on the pads to achieve a 26% return on investment (ROI) if it sells all of the pads it can produce. b. What selling price per sleeping pad will the company establish if it uses a markup percentage on absorption cost? (Round intermediate calculations and final answer to 2 decimal places.) c. Assume that the company is able to sell all of the pads that it can produce. Prepare an income statement for the first year of activity. Compute the company’s ROI based on the first year of activity. 2. After marketing the sleeping pads for several years, the company is experiencing a falloff in demand due to an economic recession. A large retail outlet will make a bulk purchase of pads if its label is sewn in and if an acceptable price can be worked out. What is the minimum acceptable price for this special order? (Round your answer to 2 decimal places.)

Answer 1

1.

(a) number of pads manufactured each year

105,000 direct labour hours / 3 per hour per pad = 35,000 pads

selling and administrative expenses :

variable (35000 * 9 per pad ) $ 315,000

Fixed $2,761,000

total $3,076,000

Markup percentage on absorption cost = (494,000 + 3,076,000) / 35000 * $85

=3,570,000 / 2,975,000 = 120 %

# 1,900,000 * 26 % = 494,000

(b) selling price

direct material	19
direct labour	27
manufacturing overhead	39
unit product cost	85
Add: markup: 120% of unit product cost	102
selling price	$ 187

(c)   Wilderness Products, Inc.

Income statement

sales (35,000pads * $187)		6,545,000
cost of goods sold (35000pads * $85)		2,975,000
Gross margin		3,570,000
selling and administartive expenses:
variable expenses	315,000
fixed expenses	2,761,000
total selling & administrative expenses		3,076,000
Net operating income		$494,000

ROI = (net operating income / average operating assets or average investment)

= ($494,000 / $1,900,000 )

= 26 %

(2)

total variable cost = direct material+ direct labour + variable manufacturing overhead + variable selling expenses

= 19 + 27 +39 * 20 % + 9

= $62.8

If the company has idle capacity and sales to the retail outlet would not affect regular sales, any price above the variable cost of $ 62.80 would add to profits. The company should aggressively bargain for more than this price : i.e $ 62.8 is simply the bottomline price below which the company should not charge.