Question

Johnson Builders builds 1,500-square-foot starter tract homes in the fast-growing suburbs of Atlanta. Land and labor are cheap, and competition among developers is fierce. The homes are a standard model, with any upgrades added by the buyer after the sale. Johnson Builders’s costs per developed sublot are as follows:

Land \(50,000

Construction 123,000

Landscaping 9,000

Variable selling costs 8,000

Johnson Builders would like to earn a profit of 14% of the variable cost of each home sold. Similar homes offered by competing builders sell for \)207,000 each. Assume the company has no fixed costs.

Requirements

1. Which approach to pricing should Johnson Builders emphasize? Why?

2. Will Johnson Builders be able to achieve its target profit levels?

3. Bathrooms and kitchens are typically the most important selling features of a home. Johnson Builders could differentiate the homes by upgrading the bathrooms and kitchens. The upgrades would cost \(16,000 per home but would enable Johnson Builders to increase the sales prices by \)28,000 per home.

(Kitchen and bathroom upgrades typically add about 175% of their cost to the value of any home.) If Johnson Builders makes the upgrades, what will the new cost-plus price per home be? Should the company differentiate its product in this manner?

Short answer

Answer

The target full product cost of the company is$180,400.

Step-by-step solution

Step-by-Step SolutionStep 1: Meaning of Price Taker

The term “price taker” is used for the company that has control over the prices of its products and services because the product of the company is unique. The price-taker companies use thetarget pricing approach to fix the prices.

Emphasize pricing

According to the given scenario, the company should use the target pricing approach because the company is a price-taker in this case. Under this approach, a company estimates thecompetitive price in the market and considers thestandard profit margin.

Computation of cost-plus price

Particulars	Amounts ($)
Revenue per home	207,000
Less: Desired profit (14%*190000)	(26,600)
Target full product cost	$180,400

Working Notes:

Computation of total variable cost:

Particulars	Amounts ($)
Land	50,000
Construction	123,000
Landscaping	9,000
Variable selling costs	8,000
Total relevant variable costs	$190,000

Computation of upgraded selling price

Particulars	Amounts ($)
Upgraded variable cost per home (190000+16000)	206,000
Add: Fixed cost	0
Full product cost	206,000
Add: Desired profit (14%*206,000)	28,840
Cost-plus price	$234,840

Upgraded selling price of home:

$\begin{array}{c}\mathbf{\text{Upgraded selling price of home}}\mathbf{=}\mathbf{\text{Original selling price}}\mathbf{+}\mathbf{\text{Increase in sales price}}\\ \mathbf{=}\mathbf{\$}\mathbf{207}\mathbf{,}\mathbf{000}\mathbf{+}\mathbf{\$}\mathbf{28}\mathbf{,}\mathbf{000}\\ \mathbf{=}\mathbf{\$}\mathbf{235}\mathbf{,}\mathbf{000}\end{array}$