Question

Smith and Company is considering adding a bike to its current product line. John, the top manager believes that in order to be competitive, the bike cannot be priced above $139. The company requires a minimum return of 25% on its investments. Launching the new bike would require an investment of $8,000,000 and sales are expected to be 40,000 units of the bike per year. Compute the target cost of a bike. What does this target cost mean for Smith and Company?

Answer 1

At 40,000 units level:

a.

Total Sales

40,000

x

$        139

=

$       55,60,000

b.

Minimum return

=

Investment x Return on Investment

=

$       80,00,000

x

25%

=

$       20,00,000

c.

Total Sales

$       55,60,000

Target Profit

$       20,00,000

Target Costs

$       35,60,000

d.

Target Cost

a

$       35,60,000

Sales units

b

40,000

Target Cost per unit

a/b

$                89.00

Thus, Target cost per unit is

$      89.00

At the inception of time, sometimes an estimation is made that cost of product would not be go above to an estimated price.

In the current case, Smith and company should manage cost in such a way that cost of product should not go beyond $ 89 each unit.

If cost increases from the target cost profit will reduce and effect decision consequently.