Murphy Productions is a price-taker

Question

The company produces generators in a highly competitive market; thus, it uses target pricing. The current market price is $600 per unit. The company has $18,500,000 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 65,000 units per year
Variable costs $500 per unit
Fixed costs $7,500,000 per year

Currently the cost structure is such that the company cannot achieve its profit objective and must cut costs. If variable costs cannot be reduced, how much reduction in fixed costs will be needed to achieve the desired target? Show all computations.
What will be an ideal response

Answer 1

Current variable costs ($500 x 65,000 units) $32,500,000
Plus: Fixed costs 7,500,000
Full product cost $40,000,000

Total sales ($600 x 65,000 units) $39,000,000
Less: Target profit ($18,500,000 x 8%) 1,480,000
Target cost $37,520,000

Fixed costs must be reduced by $2,480,000 ($40,000,000 - $37,520,000 ) to achieve the profit target.