Question

Green Thumb operates a commercial plant nursery, where it propagates plants for garden centers throughout the region. Green Thumb has \(5,300,000 in assets. Its yearly fixed costs are \)625,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total \(1.70. Green Thumb’s volume is currently 490,000 units. Competitors offer the same plants, at the same quality, to garden centers for \)4.00 each. Garden centers then mark them up to sell to the public for \(9 to \)12, depending on the type of plant.

Requirements

1. Green Thumb’s owners want to earn an 10% return on the company’s assets. What is Green Thumb’s target full product cost?

2. Given Green Thumb’s current costs, will its owners be able to achieve their target profit?

3. Assume Green Thumb has identified ways to cut its variable costs to \(1.55 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit?

4. Green Thumb started an aggressive advertising campaign strategy to differentiate its plants from those grown by other nurseries. Green Thumb does not expect volume to be affected, but it hopes to gain more control over pricing. If Green Thumb has to spend \)135,000 this year to advertise and its variable costs continue to be $1.55 per unit, what will its cost-plus price be? Do you think Green Thumb will be able to sell its plants to garden centers at the cost-plus price? Why or why not?

Short answer

The target full cost for the company is$1,430,000.

Step-by-step solution

Meaning of Variable Cost

As the name suggests, variable cost refers to the cost that varies with the level of production. In other terms, the variable cost has a direct relation with the production level; if the production level decreases, the variable cost also decreases and vice versa.

Computation of target full product cost

Particulars	Amounts ($)
Revenue at market price (490000*4)	1,960,000
Less: Desired profit (5300000*10%)	(530,000)
Target full cost	$1,430,000

Analysis of the achievement of target profit

Particulars	Amounts ($)
Revenue (490000*4)	1,960,000
Less: Variable cost (490000*1.70)	833,000
Contribution margin	1,127,000
Less: Fixed costs	(625,000)
Operating income (A)	$502,000
Target profit (B) [5,300,000*10%]	$530,000
Difference (A-B)	$(28,000)

Comment:

As per the above analysis, the owners will not be able to achieve theirtarget profit because theactual profit of the company is less than its target profit.

Computation of cost cutting and achievement of profit

Particulars	Amounts ($)
Fixed cost	625,000
Add: Variable cost (490000*1.55)	759,500
Total cost	$1,384,500

Comment:

As the new cost of $1,384,500 is less than the target cost of $1,430,000, it will allow the company to achieve its target profit.

Computation of cost-plus price

Particulars	Amounts ($)
Fixed costs	625,000
Advertising costs	135,000
Variable costs (490000*1.55)	759,500
Total costs	1,519,500
Add: Desired profit (5300000*10%)	530,000
Sales value	2,049,500
Divide: Number of units	490,000
Cost-plus price	$4.182

Comment:

As per the above analysis, the company may sell its plants at higher prices than usual market rates because by adding the advertising costs, the company has control over the pricing.