Question

Kerr Productions is a price-taker. The company produces large spools of electrical wire in a highly competitive market; thus, it uses target pricing. The current market price is $800 per unit. The company has $3,000,000 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	100,000​	units per year
Variable costs	$725​	per unit
Fixed costs	$14,000,000​	per year

Currently the cost structure is such that the company cannot achieve its profit objective and must cut costs. If fixed costs cannot be reduced, how much reduction in variable cost per unit will be needed to achieve the desired target? (Round your answer to the nearest cent.)

A)	reduction in variable cost per unit by $67.40

B)	reduction in variable cost per unit by $725.00

C)	reduction in variable cost per unit by $75.00

D)	reduction in variable cost per unit by $65.00

Answer 1

Average assets = $3,000,000

Return on investment = 8%

Net operating income = Average assets x Return on investment

= 3,000,000 x 8%

= $240,000

Number of units sold = 100,000

Profit per unit = Net operating income/Number of units sold

= 240,000/100,000

= $2.4

Selling price per unit = $800

Fixed cost = $14,000,000

Let the variable cost per unit be $K

Profit = Sales - Total Variable cost - Total fixed cost

240,000 = 80,000,000 - 100,000K - 14,000,000

100,000K = 65,760,000

K = $657.6

Hence, target Variable cost per unit = $657.6

Reduction in variable cost = Current variable cost per unit - Target variable cost per unit

= 725 - 657.6

= $67.4

Correct option is (A)