Question

Target costing

Feedastudent Ltd are developing a Gift food service for students. Market research has indicated that customers would be willing to pay £50 for the product. The company usually expect a profit margin of 10% on products.

Fixed costs for marketing and promotion is expected to be £12,000 per year. The company expects orders for 3000 units this year. Food costs are expected to be £41 per unit. Packaging and administration costs are £2 per service.

Required:

1. Calculate whether Enterprise Ltd can expect to make a profit this year.   

2. A reduction in the fixed costs of £4,000 could be achieved but this would result in a reduction of expected sales to 2000 per year. Would this reduce the cost gap and be a more profitable solution?

           [5 marks]

3. Alternatively, cheaper food costing only £38 could be used but this may affect its reputation and result in fewer sales next year. Should Enterprise consider this? Give reasons for your answer and examples of how this could work.                                                                                       

4. Alternatively, packaging and admin could be outsourced to Amazonia for an initial payment of £1200 and thereafter a variable cost of £1 per item. Is this worth considering?

5. Suggest other possible actions that Enterprise could take to enable them to make a profit.

Answer 1

Requirement A:

Particulars	Amount
Selling price	50
(-) variable Costs
Food Costs	41
Packaging	2
Total Variable Costs	43
Contribution per unit	7
Total Contributiom	21000
Fixed Promotion costs	12000
Profit	9000

The Company is able to make a Profit of 9000 pounds. But, Desired profit = 150000*10% = 15000 pounds

Requirement B :

Particulars	Amount
Selling price	50
(-) variable Costs
Food Costs	41
Packaging	2
Total Variable Costs	43
Contribution per unit	7
Sale units	2000
Total Contributiom	14000
Fixed Promotion costs	8000
Profit	6000

This strategy made a less profitable entity but not more profitable

Requirement C :

Particulars	Amount
Selling price	50
(-) variable Costs
Food Costs	38
Packaging	2
Total Variable Costs	40
Contribution per unit	10
Sale units	3000
Total Contributiom	30000
Fixed Promotion costs	14000
Profit	16000

If we look into Quantitative details, then the proposal is good. But, we should not accept this type of proposal as it will damage the reputation of the company & sales in future.

Requirement D :

Particulars	Amount
Selling price	50
(-) variable Costs
Food Costs	38
Packaging	1
Total Variable Costs	39
Contribution per unit	11
Sale units	3000
Total Contributiom	33000
Fixed Packaging costs	1200
Fixed Promotion costs	14000
Profit	17800

This alternative is gaining the desired Profit for the company without losing any future sales. But, Longiviety & package quality of the outsourcing entity to be considered.

Requirement E :

Other Possible actions to get the desired profit level was to reduce the fixed cost without loosing the sales units or Reducing Variable cost of food & packaging without compromising Quality.