Question

Ignite Products is a priceminustaker. The company produces large spools of electrical wire in a highly competitive​ market; thus, it uses target pricing. The current market price of the electric wire is $ 700 per unit. The company has $ 3 comma 200 comma 000 in average​ assets, and the desired profit is a return of 8​% on assets. Assume all products produced are sold. The company provides the following​ information: Sales volume 120 comma 000 units per year Variable costs $ 690 per unit Fixed costs $ 14 comma 000 comma 000 per year If fixed costs cannot be​ reduced, how much reduction in variable costs will be needed to achieve the desired​ target?

Answer 1

$108.8 per unit

Step-by-step explanation:

Given that,

Current market price of the electric wire = $700 per unit

Average assets = $3,200,000

Desired profit: Return on assets = 8%

Sales volume = 120,000 units per year

Current variable costs = $ 690 per unit

Fixed costs = $ 14,000,000 per year

Target profit:

= Average assets × Return on assets

= 3,200,000 × 8%

= $256,000

Let the target variable cost per unit be $X

Total variable cost:

= Number of units × Variable cost per unit

= 120,000 × X

= 120,000 X

Sales Revenue:

= Number of units sold × Selling price per unit

= 120,000 × $700

= $84,000,000

Profit = Sales Revenue - Total variable cost - Total fixed cost

$256,000 = $84,000,000 - 120,000 X - 14,000,000

X = $69,744,000 ÷ 120,000

= $581.2

Target variable cost per unit = $581.2

Reduction in variable cost per unit is calculated as follows:

= Current variable cost per unit - Target variable cost per unit

= $690 per unit - $581.2

= $108.8

Therefore, the reduction of $108.8 per unit in variable costs will be needed to achieve the desired​ target.