Chapter 25: Q25-10RQ (page 1406)
What is target pricing? Who uses it?
Answer
Target pricing is a technique or process that a business uses to compute the price of a new product based onmarket prices.
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Members of the board of directors of Security Team have received the following operating income data for the year ended March 31, 2018:
SECURITY CHECK Income Statement For the Year Ended May 31, 2018 |
Product Line |
Industrial Systems | Household Systems | Total |
Net Sales Revenue | \( 300,000 | \) 330,000 | \( 630,000 |
Cost of Goods Sold: | |||
Variable | 35,000 | 42,000 | 77,000 |
Fixed | 210,000 | 63,000 | 273,000 |
Total Cost of Goods Sold | 245,000 | 105,000 | 350,000 |
Gross Pro๏ฌt | 55,000 | 225,000 | 280,000 |
Selling and Administrative Expenses: | |||
Variable | 66,000 | 77,000 | 143,000 |
Fixed | 39,000 | 28,000 | 67,000 |
Total Selling and Administrative Expenses | 105,000 | 105,000 | 210,000 |
Operating Income (Loss) | \) (50,000) | \( 120,000 | \) 70,000 |
Members of the board are surprised that the industrial systems product line is losing money. They commission a study to determine whether the company should drop the line. Company accountants estimate that dropping industrial systems will decrease fixed cost of goods sold by \(81,000 and decrease fixed selling and administrative expenses by \)15,000.
Requirements
1. Prepare a differential analysis to show whether Security Team should drop the industrial systems product line.
2. Prepare contribution margin income statements to show Security Teamโs total operating income under the two alternatives: (a) with the industrial systems line and (b) without the line. Compare the difference between the two alternativesโ income numbers to your answer to Requirement 1.
3. What have you learned from this comparison in Requirement 2?
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 \(1.70. Green Thumbโs volume is currently 490,000 units. Competitors offer the same plants, at the same quality, to garden centers for \)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 Thumbโs owners want to earn an 10% return on the companyโs assets. What is Green Thumbโs target full product cost?
2. Given Green Thumbโs 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?
Refer to details about Skiable Acres from Short Exercise S25-2. Assume that Skiable Acresโs reputation has diminished and other resorts in the vicinity are charging only \(85 per lift ticket. Skiable Acres has become a price-taker and will not be able to charge more than its competitors. At the market price, Skiable Acres managers believe they will still serve 725,000 skiers and snowboarders each season.
Requirements
1. If Skiable Acres cannot reduce its costs, what profit will it earn? State your answer in dollars and as a percent of assets. Will investors be happy with the profit level?
2. Assume Skiable Acres has found ways to cut its fixed costs to \)30,000,000. What is its new target variable cost per skier/snowboarder?
What is differential analysis?
What questions should managers answer when considering selling a product as is or processing further?
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