Question

Net sales for the year were $510,000 and cost of goods sold was $357,000 for the company's existing products. A new product is presently under development and has an expected selling price of $70 per unit in order to remain competitive with similar products in the marketplace. What is the maximum cost per unit that can be incurred to manufacture the new product such that the product can be priced at $70 per unit and will not result in a

reduction to the company's gross profit ratio?
Multiple Choice
$51.00
$49.00
$35.00
$42.00

Answer 1

$35.00

Step-by-step explanation:

Define

P is profit per unit

Pr is Profit Ratio

S is Selling Price per unit

C is Cost per unit

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Profit ratio (Pr) is the ratio of profit/unit (P) divided by the cost (C):

Pr = P/S

The attached table summarizes the following calculations.

For the current products, we can calculate the current Pr:

Profit is Sales - Costs

Profit is ($510,000 - $357,000) or $253,000

The current Pr is ($253,000/$510,000) or 0.4961

We want to maintain this ratio for the new product, which has been determined must be sold at a price of $70 per unit.

We want to find a cost target for the new item that maintains the company's current profit ratio. The per unit profit from the new product will be ($70 - C) [$70/unit - Cost/unit].

The new product: S = $70, Pr = 0.4961, and P = ($70 - C).

We can write: 0.4961 = (70-C)/70 [Pr = P/S]

34.7 = 70-C

C = $35

The new product should cost $35 or less to avoid a negative impact on the company's current profit ratio.