Question

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Just want to compare.

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i-Covers Company manufactures designer cases for cell phones. Each cover sells for

$20.00. The cost currently assigned to each decal is $12.00. A competitor is introducing a

new designer line of cases that will sell for $16.00 each.

Management of i-Covers believes it must lower its selling price to $16.00 in order to

compete in this highly cost-conscious market. Marketing believes that the new selling price

will allow i-Covers to maintain the current sales level in units. i-Covers Company's sales

are currently 300,000 designer cases per year.

a. What is the target cost for the new selling price if target profit is 40 percent of the

new selling price?

b. What is the target selling price if costs cannot be reduced and target profit is

changed to 25 percent of the new selling price?

c. What is the change in operating income for the year if $15.00 is the new selling price

and costs remain the same but sales increase to 500,000 units?

d. What is the target cost per unit if the selling price is reduced to $16.00 and the

company wants to maintain its same total net income as when the selling price was

$20.00? Assume that sales will increase to 500,000 decals.

e. Describe value engineering and its role in target costing.

Answer 1

A. New Selling Price is $16/unit, target profit is 40% i.e. 16*.4= $6.4. Thus cost is Sale price-Profit=16-6.4= $9.6

B. Let new selling price be X. THus profit =.25X and cost = 0.75X. Cost can not be changed i.e. it is $12unit. Thus sale price = 12/(X-.25X) = $16/unit

C Current profit per unit is $8 ($20-$12). Total Unit sold = 300,000 . Total Profit = 300000*8= $2.4 million. Net unit sold 500,000 Net Profit $3 ($15-$12). Total Profit = 500,000*3= 1.5 miliion. Thus by reducing selling price by $5/unit profit will decline by $0.9 million.

D. Current Profit is $2.4 million (as computed in c above). Total Sales is 500,000 unit i.e. 500,000*$16 = $8 million. Thus total cost = $8 million - $ 2.4 million = 5.6 million i.e. $11.2 per unit is the cost.

E. Value engineering is the process in which a product is redesigned to provide more value to the customers. It helps the organization in reducing the cost of the product by removing non-productive activities. By value engineering, a company can reduce its cost. Under target costing a target cost is defined well in advance and by value engineering the cost can be achieved by the company.

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