Question

Wilderness Products, Inc., has designed a self-inflating sleeping pad for use by backpackers and campers. The following information is available about the new product:

1. An investment of $1,050,000 will be necessary to carry inventories and accounts receivable and to purchase some new equipment needed in the manufacturing process. The company’s required rate of return is 12% on all investments.
2. A standard cost card has been prepared for the sleeping pad, as shown below:

	Standard Quantity or Hours		Standard Price or Rate				Standard Cost
Direct materials	6	yards	$	2.10	per yard		$	12.60
Direct labor	4	hours	$	6.70	per hour			26.80
Manufacturing overhead (20% variable)	4	hours	$	10.90	per hour			43.60
Total standard cost per pad							$	83.00

3. The only variable selling and administrative expense will be a sales commission of $7 per pad. The fixed selling and administrative expenses will be $1,540,800 per year.
4. Because the company manufactures many products, no more than 72,000 direct labor-hours per year can be devoted to production of the new sleeping pads.
5. Manufacturing overhead costs are allocated to products on the basis of direct labor-hours.

Required:

1. Assume that the company uses the absorption approach to cost-plus pricing.

a. Compute the markup percentage that the company needs on the pads to achieve a 12% return on investment (ROI) if it sells all of the pads it can produce.

b. What selling price per sleeping pad will the company establish if it uses a markup percentage on absorption cost? (Round intermediate calculations and final answer to 2 decimal places.)

c. Assume that the company is able to sell all of the pads that it can produce. Compute the company’s ROI based on the first year of activity.

2. After marketing the sleeping pads for several years, the company is experiencing a falloff in demand due to an economic recession. A large retail outlet will make a bulk purchase of pads if its label is sewn in and if an acceptable price can be worked out. What is the minimum acceptable price for this special order? (Round your answer to 2 decimal places.)

Answer 1

Number of pads that can be produced = Labor hours available/labor hours per unit

= 72000/4

= 18,000 units

Total cost under absorption costing = 83*18000 =$1,494,000

Return required = 1050,000*12% =$126,000

Mark up = (selling and admin costs+ return)/cost

=(7*18000+1540800+126000)/1494000

= 120%

B. Selling price per pad = 83+83*120%

=$182.6

C.ROI = Operating income/investment

=(182.6-83-7)*18000-1540800/1050,000

= 12%

2. Minimum price = variable cost per unit since no additional fixed cost will be incurred due to spare capacity

= 12.60+26.80+43.60*20%

=$48.12 per pad as sales commission will not be paid on this sale

The price will be $55.12 if commission is paid