Question

Mcquade Equipment is considering a new product for the road construction industry. The analyst has collected some information about the product design summarized as follows: Prime cost per unit $ 5,240 Conversion cost per unit 3,880 Direct labor cost per unit 2,100 The marketing group at Mcquade believes this product can be a success if sold at a price of $8,430 per unit. Mcquade desires an operating profit (as a percentage of costs) of 25 percent on products of this type. Required: a. Will Mcquade achieve its target operating profit based on these product characteristics? b. A product engineer suggests that they are still uncertain about the direct material costs. By how much would direct material cost have to fall or by how much could they increase direct material cost per unit such that the desired operating profit would be met exactly?

Answer 1

Mcquade Equipment will not achieve its target operating profit with a selling price of $8,430 per unit since the target selling price required to achieve a 25% profit margin is $11,400. The direct material cost must be $764 or lower to meet the desired operating profit margin.

Step-by-step explanation:

To determine if Mcquade Equipment will achieve its target operating profit based on the product characteristics provided, we need to calculate the total cost and then apply the desired profit margin to find the target selling price.

First, we calculate the total cost per unit by adding the prime cost and the conversion cost.

• Prime cost per unit = $5,240
• Conversion cost per unit = $3,880
• Total cost per unit = Prime cost + Conversion cost = $5,240 + $3,880 = $9,120

Mcquade desires a 25% operating profit on this cost, so the target selling price should be:

Target selling price = Total cost per unit (1 + Desired Profit Margin) = $9,120 * (1 + 0.25) = $9,120 * 1.25 = $11,400

The marketing group at Mcquade believes the product can be sold for $8,430 per unit, which is lower than the target selling price of $11,400. Therefore, based on these characteristics, Mcquade will not achieve its target operating profit.

To identify by how much the direct material cost per unit would need to change to meet the desired operating profit exactly, we can work backwards from the target selling price determined by the desired profit margin:

Allowed cost at 25% profit margin = Target selling price / (1 + Desired Profit Margin) = $8,430 / 1.25 = $6,744

Then, subtract the other costs to find the direct material cost:

Allowed direct material cost = Allowed cost - Direct labor cost - Conversion cost = $6,744 - $2,100 - $3,880

Therefore, the direct material cost per unit should be $764 or lower to achieve the desired operating profit margin of 25% at the selling price of $8,430.