Question

Kerr Production is a price-taker. The company produces large spools of electrical wire in a highly competitive market; thus, it uses target pricing. The current market price is $850 per unit. The company has $3,000,000 in average assets and the desired profit is a return of 6% on assets. Assume all products produced are sold. The company provides the following information:

Sales volume 100,000 units per year

Variable costs   $750 per unit

Fixed costs $14,000,000 per year

Currently the cost structure is such that the company cannot achieve its profit objective and must cut costs. If fixed costs cannot be reached, how much reduction in variable costs per unit will be needed to achieve the desired target? (Round your answer to the nearest cent.)

A. reduction in variable cost per unit by $40.00

B. reduction in variable cost per unit by $750.00

C. reduction in variable cost per unit by $41.80

D. reduction in variable cost per unit by $100.00

Answer 1

Average assets = $3,000,000

Return on assets = 6%

Target profit = Average assets x Return on assets

= 3,000,000 x 6%

= $180,000

Sales volume = 100,000 units

Total fixed cost = $14,000,000

Selling price per unit = $850

Let the target variable cost per unit be $Y

Total variable cost = Number of units x Variable cost per unit

= 100,000 x Y

= 100,000Y

Sales = Number of units sold x Selling price per unit

= 100,000 x 850

= $85,000,000

Profit = Sales - Total variable cost - Total fixed cost

180,000 = 85,000,000-100,000Y-14,000,000

Y = $708.20

Variable cost per unit = $708.20

Current variable cost per unit = $750

Target variable cot per unit = $708.20

Hence, reduction in variable cost per unit = Current variable cost per unit - Target variable cot per unit

= 750-708.20

= $41.80

Correct option is C.

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