Question

A new product is being evaluated. Market research has surveyed the potential market for this product and believes that it will generate a total demand of 50,000 units at average price of $280. Total sots for the various value-chain functions using existing process technology are:

Value Chain Function	Total cost over Product life
R & D	4,510,000
Design	730,000
Manufacturing	3,000,000
Marketing	900,000
Distribution	1,100,000
Customer Service	760,000
Total Cost over product life	$11,000,000

Management has a target profit percentage of 40% of sales. Production engineering indicates that a new process technology can reduce the manufacturing cost by 40% but it will cost $150,000.

1. Assuming the existing process technology is used, should the new product be releases to production?

The unit target cost is $X. The expected average unit cost if the new product is release to production would be $X. The new product Should/Should not be released to production because the expected average unity cost is greater than/less than the unit target cost.

2. Assuming the new process technology is purchased, should the new product be released to production?

First calculate the total cost savings if the new process technology is purchased.

The total cost savings will be $X.

If the new process technology is purchased, the expected average unity cost will be $X. The new product should/should not be released to production because the expected average unit cost is greater than/less than the unit target cost.

Answer 1

IN this problem, we have to decide whether the new product is to be produced or not.

A selling price and a desired profit percentage is given. The total cost for production is also given.

Step 1 .

Computation of Target Cost

Target Cost = Selling Price - Desired Profit

  = 280 - 40% of 280

= 280 - 112

= $ 168

Target Cost = $ 168

Step 2

Computation of Cost per Unit - Current Scenario

Particulars (Item of Cost	Amount in $
R& D	4,510,000
Design	730,000
Manufacturing	3,000,000
Marketing	900,000
Distribution	1,100,000
Customer Service	760,000
Total Cost ( A)	11,000,000
Total Quantity to be Produced (B)	50,000
Cost per Unit (A/B)	220

The Current Manufacturing cost is $ 220 per unit and the target cost is $ 168. The manufacturing cost is less than the target cost. Hence the product should not be produced.

SUB PART 2

Use of New Technology for Production - Evaluation of the Proposal

Step 1 - Computation of Cost Savings

Savings in Cost = Decrease in Cost - Expenses for implementation of New technology

= 40% of manufacturing cost - implementation cost of $ 150,000

= 40% * 3,000,000 - 150,000

= 1,200,000 - 150,000

= $ 1,050,000

Step 2 - Computation of Revised Total Cost

Revised Total Cost = Current Total Cost - Savings in cost due to implementation of New technology

= 11,000,000 - 1,050,000

= $ 9,950,000

Per Unit Revised Cost = $ 9,950,000 / 50,000 = $ 199.

In this scenario, the revised unit cost of product is $ 199 while the target cost remains at $ 168. The estimated cost is more than the target cost. Hence the product should not be produced.