Financial Performance Target costing/ production question

Toby82

Hi,

My mind has gone completely blank on how to answer the following question… I was wondering if someone could help!

Alpha ltd is considering designing a new product, product BPT and will use target costing to arrive at the target cost of the product. You have been given the following information.

The price the product will be sold at has not been decided

It has been estimated that if the price is set at £40 the demand will be 500,000 units, and if the price is set at £50 the demand will be 430,000 units.

The cost of production include fixed production costs of £8.500.000 which will give production capacity of 500,000 units.

In order to produce above this level the fixed costs will step up by £1,500,000

The required profit margin is 30%

The variable cost per unit is 13 for the production volume of 430,000 units

For production volume of 500,000 units the variable cost will be 12 per unit.

A) Complete the table Sales price £40 Sales price £50

The Target to total production cost per unit

The target fixed production cost per unit

The target fixed production cost


Any help will greatly be appreciated

zippi

Hi Toby82,

I recently passed my FP exam but did find this question tough whilst doing it. Anyway will try my best if not there are other experts here who can help you.

Req. profit margin is 30%, so basically easiest way to find 1) the target total production cost per unit for sale price of £40 is £40-30% gives you £28 or the book way is £40 x 70/100 which still gives you £28 as you have to achieve the profit margin of 30%. Same goes with £ 50-30-% gives you target total production cost per unit of £ 35 or you can use book methods whichever way you are comfortable with.

Now well you know that variable production cost for 500,000 units (£40 per unit) is £12, therefore target fixed production cost per unit is total prod. Cost less var. cost £28-£12=£16 and variable cost per 430,000 units (£50 per unit) is £13, therefore £35-£13=. £22.

Now that we know the fixed cost per unit of both the target fixed production cost we can find the total target fixed production for both. Therefore target fixed production cost for sale price £40 is £16 x 500000 units gives £8000,000. (8million) and target fixed production cost for sale price £50 is £22 x 430,000 unit gives £9,460,000 (9.6 million).

Alpha should set price at £50 inorder to achieve the target profit margin. Hop this helps

zippi

Hope this helps, sorry about the spelling mistake!

Toby82

Thank you very much for your help with this Zippi!

zippi

My pleasure!

hasan

Thanks mate