Buffington, Inc. produces a number of components that are used in home theater systems. Mike Boston, head of the company's market research department, has identified the need for a new component that will most likely sell for $75. Projected volume levels are anticipated to reach 28,000 units in the first year, as several firmly entrenched competitors will be introducing a similar product in the not-too-distant future.Conversations with Buffington's engineers and reviews of cost accounting data related to similar products that the company manufactures resulted in the following cost estimates for the new component:Direct materials$18Direct labor36Manufacturing overhead16Selling and administrative 5Buffington currently uses cost-plus pricing and adds a 20% markup on total production cost to
arrive at what is normally a competitive selling price.Required:A. What is the anticipated selling price of the new component if Buffington uses its current pricing policy? What difficulties, if any, might the company face in the marketplace?B. Assume that Buffington decides to switch to target costing. What price would the company charge for the new component?C. With the switch to target costing, what would Buffington have to do to the component's manufacturing cost to achieve the normal profit margin on sales? Be specific and show calculations.
What will be an ideal response?
A. The total production cost is $70 ($18 + $36 + $16), and the addition of a 20% markup yields an $84 selling price ($70 × 120%). Unless the new component has some extra features that consumers find attractive, overall sales might suffer because $84 exceeds the expected competitive price of $75.
B. $75 (the expected competitive selling price)
C. Buffington's markup is $14 ($84 - $70), which is 16.67% of the current $84 selling price ($14 ÷ $84). To achieve a 16.67% markup on a $75 selling price, the company must reduce its production costs by $7.50.
| Selling price | $75.00 |
| Less: 16.67% markup ($75 × 16.67%) | 12.50 |
| Target cost | $62.50 |
| ? | ? |
| Current cost | $70.00 |
| Less: Target cost | 62.50 |
| Required cost reduction | $ 7.50 |
D. Buffington can use value engineering, which focuses on cost reduction and process improvement. Information is collected about a product's design and manufacturing processes, and attempts are made to identify areas of change and where general improvements in efficiency are possible.
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