Target Costing and Cost Analysis For Pricing Decisions: Answers To Review Questions

CHAPTER 15
Target Costing and Cost Analysis for Pricing

Decisions
ANSWERS TO REVIEW QUESTIONS
15.1
Four major influences on pricing decisions are as follows:

(1) Customer demand: Management must consider customers demand for their
product, which reflects the price that customers are willing to pay for the
product.
(2) Actions of competitors: When pricing its product, management must consider
the likely pricing decisions and product design decisions of competing firms.
(3) Costs: No organization or industry can price its product below total production
costs indefinitely.
(4) Political, legal, and image-related issues: Management must consider the way the
public perceives the firm and must adhere to certain laws when setting prices.
15.2
The statement that prices are determined by production costs is too simplistic.
Although firms must price their products and services above their total costs in the
long run, management cannot ignore demand issues and the economic environment.
Setting prices generally is a balance between cost-related issues and economic
market forces.
15.3
In the long run, every organization must price its product or service above the total
cost of production. While the market for the product also is critically important, costs
cannot be ignored.
15.4
It is crucial to define the firms product when considering the reaction of

competitors, so that the competitors can be identified. For example, is a firm that
produces glass bottles competing only with other firms that produce glass bottles,
or is the firm competing with all companies that produce containers? Defining the
product as glass bottles or containers is an important step in identifying who the
firms competitors are.
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Managerial Accounting, 5e
2002 The McGraw-Hill Companies,

15- 1
15.5
In most industries, both market forces and cost considerations heavily influence
prices. No organization can price its products below their production costs in the
long run. On the other hand, no company can set prices at cost plus a markup
without keeping an eye on the market. The product or service must be sold at a price
customers are willing to pay.
15.6
The profit-maximizing price is the price for which the associated quantity is
determined by the intersection of the marginal cost and marginal revenue curves.
This intersection is shown in Exhibit 15-3 in the text.
15.7
(a) Total revenue: Price multiplied by quantity sold.

(b) Marginal revenue: The amount by which total revenue increases when one
additional unit is sold.
(c) Demand curve: A graphical or mathematical expression of the relationship
between the price and the quantity sold.
(d) Price elasticity: The impact of price changes on sales volume.
(e) Cross-elasticity: The extent to which a change in a products price affects the
demand for substitute products.
15-8
(a) Total cost: Unit cost multiplied by quantity produced.

(b) Marginal cost: Additional cost when one more unit is produced.
15.9
Three limitations of the economic, profit-maximizing model of pricing are as follows:

(1) The firms demand and marginal revenue curves are difficult to determine with
precision.
(2) The marginal-cost, marginal-revenue paradigm, as described in the text, is not
valid for all forms of market organization.
(3) Cost-accounting systems are not designed to measure the marginal changes in
cost incurred as production and sales increase unit by unit. To measure marginal
cost would entail a very costly information system.
15.10 Determining the best approach to pricing requires a cost-benefit trade-off. While the
marginal-cost, marginal-revenue paradigm results in a profit-maximizing price, only a
sophisticated and costly information system can collect marginal-cost data. Thus,
the firm will incur greater cost in order to obtain better decisions.
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Solutions Manual
15.11 The general formula for cost-plus pricing is as follows:

Price = cost + (markup percentage cost)
The price is equal to cost plus a markup. Depending on how cost is defined, the
markup percentage may differ. Several different definitions of cost, each combined
with a different markup percentage, can result in the same price for a product or
service.
15-12 The four cost bases commonly used in cost-plus pricing are the following:
absorption manufacturing cost, total cost, variable manufacturing cost, and total
variable cost. Each of these cost bases can result in the same price under costbased pricing if the markup percentage used in the cost-plus pricing formula is
changed. For example, a lower markup percentage would be applied to total cost
than would be applied to total variable cost.
15.13 Four reasons often cited for the widespread use of absorption cost as the cost base
in cost-plus formulas are as follows:
(1) In the long run, the price must cover all costs and a normal profit margin.
(2) Absorption-cost and total-cost pricing formulas provide a justifiable price that
tends to be perceived as equitable by all parties.
(3) When a companys competitors have similar operations and cost structures,
cost-plus pricing based on full costs gives management an idea of how
competitors may set prices.
(4) Absorption-cost information is provided by a firms cost-accounting system,
because it is required for external financial reporting under generally accepted
accounting principles. Since absorption-cost information already exists, it is
cost-effective to use for pricing.
15.14 The primary disadvantage of absorption-cost or total-cost pricing formulas is that
they obscure the cost behavior pattern of the firm. Since absorption-cost and totalcost data include allocated fixed costs, it is not clear from these data how the firms
total costs will change as volume changes.
15.15 Three advantages of pricing based on variable cost are as follows:
(1) Variable-cost data do not obscure the cost behavior pattern by unitizing fixed
costs and making them appear variable.
(2) Variable-cost data do not require allocation of common fixed costs to individual
product lines.
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15- 3
(3) Variable-cost data are exactly the type of information managers need when facing
certain decisions, such as whether to accept a special order.
15.16 The behavioral problem that can result from the use of a variable-cost pricing
formula is that managers may perceive the variable cost of a product or service as
the floor for the price. They may tend to set the price too low for the firm to cover its
fixed costs.
15.17 Return-on-investment pricing is an approach under which the price is set so that it
will cover costs and also earn a profit that will provide a target return on the invested
capital.
15.18 Price-led costing refers to the process under target costing of first determining the
acceptable market price for a product or service and then determining the cost at
which the product or service must be produced.
15.19 To be successful at target costing, management must listen to the companys
customers. By doing so, management will learn the products, features, and quality
that customers are willing to buy as well as the price they are willing to pay.
15.20 Value-engineering is a cost-reduction and process-improvement technique used to
help bring the cost of manufacturing a product or providing a service into line with
its target cost.
15.21 Tear-down methods can be used in a service-industry firm just as they are used in
the manufacturing industry. The various steps in providing a service can be
analyzed for cost improvements just as a products materials and manufacturing
operations can be analyzed for the same purpose.
15.22 Under time-and-material pricing, the price includes a cost-based charge for labor, a
cost-based charge for material, and generally a markup on one or both of these
production-cost factors.
15.23 When a firm has excess capacity, there is no opportunity cost in accepting an
additional production job. Therefore, it is not necessary to reflect such an
opportunity cost in setting a bid price. On the other hand, if the firm is already at full
capacity, there is an opportunity cost to accepting another production job. In this
case, it is appropriate to include in the price an estimate of the opportunity cost
associated with the job for which the bid is being prepared.
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Solutions Manual
15.24 The decision to accept or reject a special order and the selection of a price for a
special order are similar decisions. If a price has been offered for a special order,
management can base its acceptance or rejection decision on whether or not that
price covers the incremental cost of producing the order. Another way of viewing the
problem is to set the minimum price for the special order at a level sufficient to cover
the incremental cost of producing the order.
15.25 (a) Skimming pricing: Setting a high initial price for a new product in order to reap
short-run profits. Over time, the price is reduced gradually.
(b) Penetration pricing: Setting a low initial price for a new product in order to
penetrate a market deeply and gain a large and broad market share.
(c) Target costing: Conducting market research to determine the price at which a
new product will sell and then, given the likely sales price, computing the cost for
which the product must be manufactured in order to provide the firm with an
acceptable profit margin. Then engineers and cost analysts work together to
design a product that can be manufactured for the allowable cost. This process
is used widely in the development stages of new products.
15-26 (a) Unlawful price discrimination: Quoting different prices to different customers for
the same product or service, even though the different prices cannot be justified
by differences in the cost incurred to produce, sell, and deliver the product or
service.
(b) Predatory pricing: Temporarily cutting a price to broaden demand for a product
with the intention of later restricting the supply and raising the price again.
15-27 Traditional, volume-based product-costing systems often overcost high-volume and
relatively simple products while undercosting low-volume and complex products.
This practice can result in overpricing high-volume and relatively simple products
and underpricing low-volume and complex products. Such strategic pricing errors
can have a disastrous impact on a firms competitive position.
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15- 5
SOLUTIONS TO EXERCISES
EXERCISE 15-28 (30 MINUTES)
1.
Tabulated price, quantity, and revenue data:

(1)
(2)
Quantity
Sold per
Month
Unit
Sales
Price
20
40
60
80
100
......................................
$1,000
......................................
950
......................................
900
......................................
850
......................................
800
(3)
Total
Revenue
per
Month*
(4)
Changes
in Total
Revenue
....................................................................................
$20,000
....................................................................................
38,000 } .................... $18,000
....................................................................................
54,000 } .................... 16,000
....................................................................................
68,000 } .................... 14,000
12,000
....................................................................................
80,000 } ....................
*Column (1) times column (2).
Differences between amounts in column (3).
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Solutions Manual
EXERCISE 15-28 (CONTINUED)

2.
Total revenue curve:

Dollars
Total revenue
$80,000
$70,000
$60,000
$50,000
$40,000
Curve is increasing
throughout its range,
but at a declining rate
$30,000
$20,000
$10,000
20
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40
60
80
100
Quantity sold
per month

15- 7

1.
Tabulated cost and quantity data:
(1)
(2)
Quantity
Produced
Average
and Sold per
Cost per
Month
Unit
20
......................................
$900
40
......................................
850
60
......................................
820
80
......................................
860
100
......................................
890
(3)
(4)
Total
Changes
Cost per
in Total
Month*
Cost
....................................................................................
$18,000
....................................................................................
34,000 } ..................... $16,000
....................................................................................
49,200 } ..................... 15,200
....................................................................................
68,800 } ..................... 19,600
} ..................... 20,200
....................................................................................
89,000
Differences between amounts in column (3).
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Solutions Manual

2.
Total cost curve:
Dollars
$90,000
Total cost
$80,000
$70,000
$60,000
$50,000
Total cost increases

at an increasing rate
$40,000
$30,000
$20,000
Total cost increases

at an declining rate
$10,000
20
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40
60
80
100
Quantity sold
per month

15- 9
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15-10

Solutions Manual

1.
Tabulated revenue, cost, and profit data:
(1)
(2)
(3)
(4)
(5)
Quantity
Total
Total
Produced
Sales
Revenue
Cost
Profit
and Sold
Price
per
per
per
per Month
per Unit
Month*
Month
Month**
20
......................................
$1,000 ....................................................................................
$20,000
$18,000 ...........................................................
$2,000
40
......................................
950 ....................................................................................
38,000
34,000 ...........................................................
4,000
60
......................................
900 ....................................................................................
54,000
49,200 ...........................................................
4,800
80
......................................
850 ....................................................................................
68,000
68,800 ...........................................................
(800)
100
......................................
....................................................................................
89,000
...........................................................
800
80,000
(9,000)
Column (1) times average cost per unit given in the preceding exercise.
**Column (3) minus column (4).

2.
Total revenue and cost curves: see next page.
3.
Of the five candidate prices listed, $900 is the optimal price. This price produces a
monthly profit of $4,800, which is greater than the profit at the other four candidate
prices.
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15- 11

2.
Total revenue and cost curves:

Dollars
$90,000
Total cost
$80,000
Total revenue
$70,000
$60,000
$50,000
$40,000
Total profit at the profitmaximizing quantity and

price.
$30,000
$20,000
$10,000
20
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15-12
40
60
80
100
Quantity sold
per month

Solutions Manual

Dollars
Total cost
Total revenue
Total profit at profit-maximizing quantity and price
Quantity sold per

month
q*
Dollars per unit
Marginal cost
p*
Demand (average revenue)

Marginal revenue
Quantity sold
per month
q*
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15- 13

1.
Profit on sales of 60,000 units:

Sales revenue (60,000 6p) ...................................................
Less: Variable costs:
Manufacturing and administrative (60,000 3p) ......
Sales commissions (60,000 6p 10%) ..................
Contribution margin ...............................................................
Less: Fixed costs (60,000p + 5,000p) ....................................
Profit ........................................................................................
360,000p
180,000p
36,000p
216,000p
144,000p
65,000p
79,000p
p denotes Argentinas peso

2.
Required price on special order:

Unit contribution margin
required on special order
target additional profit

unit sales volume in special order
=
Sales price required
20,000p
2 p per unit
10,000
unit variable cost + required unit

contribution margin
3p + 2p = 5p per unit
As an alternative approach, let X denote the price required in order to earn additional
profit of 20,000p on the special order:
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15-14
10,000X 10,000(3p)
20,000p
10,000X
50,000p
5p per unit

Solutions Manual

Answers will vary widely, depending on the company and the product chosen. The answer
should include a general discussion of the use of target costing in setting a price for a
new product. The target-costing approach includes the following key features: priceled costing; focus on the customer; focus on product design; focus on process
design; use of cross-functional teams; analysis of life-cycle costs; and a value-chain
orientation. Target costing makes extensive use of value engineering to reduce
production costs and bring them into line with the target cost.
Markup percentage
applied to cost base in
cost-plus
pricing formula
1.
Markup percentage
profit required to
achieve target ROI
annual
volume
$60,000
total annual costs not

included in cost base
cost base per unit
used in cost-plus
pricing formula
total variable selling and

administrative costs
480 $400
total annual
fixed costs
$60,000 (480 $50) [480 ($250 $100)]

480 $400
$60,000 $24,000 $168,000

$192,000
= 131.25%
Thus the Wave Darters price would be set equal to $925, where
$925 = $400 + ($400 131.25%).
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15- 15

In the preceding formula:
$60,000
480
$400
$50
$250
$100
2.
=
=
=
=
=
=
target profit (given)

annual volume of Wave Darter production and sales (from Exhibit 15-5)
variable manufacturing cost per unit (from Exhibit 15-5)
variable selling and administrative cost per unit (from Exhibit 15-5)
applied fixed manufacturing cost per unit (from Exhibit 15-5)
allocated fixed selling and administrative cost per unit (from Exhibit 15-5)
$60,000
Markup percentage =
total selling and

administrative costs
480 $650*
$60,000 [480 ($50 $100)]

480 $650
$60,000 $72,000
$312,000
= 42.31% (rounded)
Thus the Wave Darters price would be set equal to $925, where
$925 = $650 + ($650 42.31%) with rounding.
*$650 = absorption manufacturing cost (from Exhibit 15-5).
The other amounts used in this formula were defined in requirement (1).
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15-16

Solutions Manual

1.
Price =total unit cost + (markup percentage total unit cost)

$450 =total unit cost + (12.5% total unit cost)
$450 =total unit cost 1.125
Total unit cost =
$450
1.125
Allocated fixed
selling and
administrative cost
2.
= $400
total
unit
cost
all
manufacturing
costs
$400($250 + $50) $60
$40
variable
selling and
administrative cost
a.
Cost-Plus Pricing Formula

Variable manufacturing cost ..................................................
$250 $450 = $250 + (80% $250)*
Applied fixed manufacturing cost .........................................
50
b.
Absorption manufacturing cost .............................................

$300 $450 = $300 + (50% $300)
$250
Variable selling and administrative
cost ........................................................................................
60
c.
Total variable cost ...................................................................

$310 $450 = $310 + (45.16% $310)**
*($450 $250) $250 = 80%

($450 $300) $300 = 50%
**($450 $310) $310 = 45.16% (rounded)
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15- 17

(1)
Cost-Plus Pricing Formula

$200 $400 = $200 + (100% $200)a
Applied fixed manufacturing cost .........................................
70
(2)
Absorption manufacturing cost .............................................

$270 $400 = $270 + (48.15% $270)b
Variable selling and administrative cost ...............................
30
Allocated fixed selling and
administrative cost ...............................................................
50
(3)
Total cost
$350 $400 = $350 + (14.29% $350)c

$200
Variable selling and administrative cost ...............................
30
(4)
Total variable cost ...................................................................

$230 $400 = $230 + (73.91% $230)d
Explanatory Notes:
a
($400 $200) $200 = 100%

($400 $270) $270 = 48.15% (rounded)
c
($400 $350) $350 = 14.29% (rounded)
d
($400 $230) $230 = 73.91% (rounded)
b

1.
Material component of time and material pricing formula:

material
material handling
material
cost
and storage costs
cost
incurred
annual cost of materials
incurred
on job
used in Repair Department
on job
2.
1.05
Material component of price, using formula developed in requirement (1):

[$8,000 + ($8,000 .04)] 1.05
= $8,320 1.05
= $8,736
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Solutions Manual

New price to be quoted on yacht refurbishment:
Total price of job = time charges + material charges
= $9,000* + $8,736**
= $17,736
*From Exhibit 15-7.
**
From requirement (1).
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15- 19
SOLUTIONS TO PROBLEMS
PROBLEM 15-38 (25 MINUTES)
1.
The manufacturing overhead rate is $18.00 per standard direct-labor hour, and the
standard product cost includes $9.00 of manufacturing overhead per pressure valve.
Accordingly, the standard direct-labor hours per finished valve is 1/2 hour ($9 $18).
Therefore, 30,000 units per month would require 15,000 direct-labor hours.
2.
The analysis of accepting the Glasgow Industries order of 120,000 units is as

follows:
Totals for
Per Unit 120,000 Units
Incremental revenue ............................................................... $19.00
$2,280,000
Incremental costs:
Variable costs:
Direct material ................................................................. $5.00
Direct labor ......................................................................
6.00
Variable overhead ........................................................... 3.00
Total variable costs ..................................................... $14.00
$600,000
720,000
360,000
$1,680,000
Fixed overhead:
Supervisory and clerical costs
(4 months @ $12,000) .......................................................
Total incremental costs ..........................................................
Total incremental profit ..........................................................
48,000
$1,728,000
$ 552,000
The following costs are irrelevant to the analysis:

Shipping
Sales commission
Fixed manufacturing overhead (both traceable and allocated)
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Solutions Manual
PROBLEM 15-38 (CONTINUED)

3.
The minimum unit price that Badger Valve and Fitting Company could accept without
reducing net income must cover the variable unit cost plus the additional fixed
costs.
Variable unit cost:
Direct material ..................................................................... $5.00
Direct labor ..........................................................................
6.00
Variable overhead ............................................................... 3.00
Additional fixed cost ($48,000 120,000) .............................
Minimum unit price .................................................................
4.
$14.00
.40
$14.40
Badgers management should consider the following factors before accepting the
Glasgow Industries order:
The effect of the special order on Badgers sales at regular prices.
The possibility of future sales to Glasgow Industries and the effects of
participating in the international marketplace.
The companys relevant range of activity and whether or not the special order will
cause volume to exceed this range.
The effect on machinery or the scheduled maintenance of equipment.
Other possible production orders that could come in and require the capacity
allocated to the Glasgow job.
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15- 21

1.
Direct-labor hours (DLH) required for job =
1,000,000 doses to be packaged

2,000 doses/DLH
= 500 DLH
Traceable out-of-pocket costs:
Direct labor ($8.00 500) .......................................................................
Variable overhead ($6.00 500) ............................................................
Administrative cost ................................................................................
Total traceable out-of-pocket costs...................................................
Minimum price per dose =
=
$4,000
3,000
1,000
$8,000
total traceable out -of -pocket costs

1,000,000 doses
$8,000
1,000,000
= $.008
2.
As in requirement (1), 500 direct-labor hours are required for the job.
Direct labor ($8.00 500) ...........................................................................
Variable overhead ($6.00 500) ................................................................
Fixed overhead ($10.00 500) ..................................................................
Administrative cost ....................................................................................
Total cost .................................................................................................
Maximum allowable return (15%) ..............................................................
Total bid price .........................................................................................
Bid price per dose
$4,000
3,000
5,000
1,000
$13,000
1,950
$14,950
total bid price
= 1,000,000 doses
$14,950
= 1,000,000
=$.01495 per dose
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Solutions Manual

3.
Under the supposition that the price computed by North American Pharmaceuticals,
Inc. using Wyants criterion is greater than $.015, the factors that North Americans
management should consider before deciding whether or not to submit a bid at the
maximum allowable price include whether North American has excess capacity,
whether there are available jobs on which earnings might be greater, and whether the
maximum bid of $.015 contributes toward covering fixed costs.

1.
Target costing is more appropriate. MPE is limited in terms of what price it can
charge due to market conditions. A cost-plus-markup approach will use the desired
markup for the company; however, the resulting price may too high and not
competitive. In such an environment it makes more sense to use target costing,
which begins with the price to be charged and works backward to determine the
allowable cost.
2.
Target profit = asset investment x rate of return

= $18,000,000 x 12%
= $2,160,000
3.
Revenue = target profit + variable cost + fixed cost

= $2,160,000 + (25,000 hours x $22) + $1,900,000
= $4,610,000
Since total revenue must equal $4,610,000, the revenue per hour must be $184.40
($4,610,000 25,000 hours).
4.
Target profit = asset investment x rate of return

= $18,000,000 x 14%
= $2,520,000
Revenue = target profit + variable cost + fixed cost
= $2,520,000 + (25,000 hours x $22) + $1,900,000
= $4,970,000
No. A 14% return requires that MPE generate revenue per service hour of $198.80
($4,970,000 25,000 hours), which is clearly in excess of the $175 market price.
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15- 23

5.
To achieve a 14% return and a $175 revenue-per-hour figure, the company must trim
its costs. MPE could use value engineering, a technique that utilizes information
collected about a services design and associated production process. The goal is
to examine the design and process and then identify improvements that would
produce cost savings.

1.
Cost-plus pricing begins by computing an items cost and then adds an appropriate
markup. The result is the items selling price. In contrast, target costing begins by
determining an appropriate selling price. A target profit is next subtracted from that
price to yield the cost (i.e., the target cost) that must be achieved.
Target costing could be labeled price-led costing because it begins by
determining a target selling price. In contrast, cost-plus pricing methods begin with
the cost and culminate in determination of the selling price.
2.
The current selling price is $225:

Direct material... $ 30
Direct labor
75
Manufacturing overhead
50
Selling and administrative expenses.
25
Total cost. $180
Markup ($180 x 25%)...
45
Selling price... $225
3.
Lenos markup is $45, which is 20% of the current $225 selling price ($45 $225). To
achieve a 20% markup on a $195 selling price, the company must reduce its costs by
$24.
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15-24
Selling price..
Less: 20% markup ($195 x 20%).
Target cost
$195
39
$156
Current cost..
Less: Target cost.
Required cost reduction
$180
156
$ 24

Solutions Manual

4.
Yes. The company should focus its efforts on trimming non-value-added costs.
These costs are associated with non-value-added activities (i.e., activities that are
either (a) unnecessary and dispensable or (b) necessary, but inefficient and
improvable).
5.
If costs cannot be reduced below $180, Leno will have to reduce its markup to
remain competitive. Assuming a desire to achieve the going market price of $195,
the markup must equal $15 ($195 - $180), or 8.33 % of cost ($15 $180). Given that
the current markup on cost is 25%, a reduction of 16.67% is needed (25.00% - 8.33%).
6.
The statement means that selling prices are a function of market conditions;
however, the selling prices must cover a companys costs in the long run. Also, in a
number of industries, prices are based on costs. Yet, the prices are subject to the
reaction of customers and competitors.

1.
Target costing is market driven, beginning with a determination of the selling price
that customers are willing to pay. That price is dependent on the product they
purchase and the products features. It is only natural that a marketing team
becomes heavily involved in this process, since customer feedback is crucial to the
design process.
2.
Add cabinet doors: [(10 x 1) + (20 x 2) + (30 x 3) + (60 x 4) + (80 x 5)] = 780; 780 200
= 3.900
Expand storage area: [(10 x 1) + (40 x 2) + (70 x 3) + (50 x 4) + (30 x 5)] = 650; 650
200 = 3.250
Add security lock: [(30 x 1) + (60 x 2) + (50 x 3) + (40 x 4) + (20 x 5)] = 560; 560 200 =
2.800
New appearance for table top: [(10 x 1) + (20 x 2) + (50 x 3) + (60 x 4) + (60 x 5)] = 740;
740 200 = 3.700
Extend warranty: [(40 x 1) + (70 x 2) + (30 x 3) + (35 x 4) + (25 x 5)] = 535; 535 200 =
2.675
McGraw-Hill/Irwin
Inc.

15- 25

Ranking (from strongest to weakest):
1Add cabinet doors (3.900)
2New appearance for table top (3.700)
3Expand storage area (3.250)
4Add security lock (2.800)
5Extend warranty (2.675)
3.
(a)
DF currently earns a $16 profit on each table sold ($80 - $64), which translates
into a 20% markup on sales ($16 $80). The current competitive market price
is $95, which means that if DF maintains the 20% markup, it will earn $19 ($95
x 20%) per unit. The maximum allowable cost is therefore $76 ($95 - $19).
(b)
Customers feel most strongly about adding cabinet doors and giving the
table top a new appearance. Both of these features can be added, and DF will
be able to earn its 20% markup. The third and fifth most desirable features
(the expanded storage area and extended warranty) are too costly. If it
desires, DF could also add a lock to the storage area. (Calculations follow.)
Maximum allowable cost... $76.00
Less: Current cost... 64.00
Cost of additional features $12.00
1Add cabinet doors. $ 6.00
2New appearance for table top
4.25
Subtotal $10.25
4Add security lock..
1.65
Total.. $11.90
4.
An expanded storage area would be the most logical additional feature in view of its
no. 3 ranking. DF might use value engineering to study the design and production
process of both the table as currently manufactured as well as the proposed new
features. The goal is to identify improvements and associated reductions in cost
that may allow the company to add previously rejected options.
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Solutions Manual

1.
The order will boost Graydons net income by $27,900, as the following calculations
show.
Sales revenue......................................................
Less: Sales commissions (10%)........................
Less manufacturing costs:
Direct material...............................................
Direct labor....................................................
Variable manufacturing overhead*...........................
Total manufacturing costs
Income before taxes...........................................
Income taxes (40%).............................................
Net income ......................................................
$165,000
16,500
$148,500
$ 29,200
56,000
16,800
102,000
$ 46,500
18,600
$ 27,900
*Based on an analysis of the year just ended, variable overhead is 30 percent of

direct labor ($2,250 $7,500). For Premiers Foods order:
Direct-labor cost x .30 = $56,000 x .30 = $16,800.
2.
Yes. Although this amount is below the $165,000 full-cost price, the order is still
profitable. Graydon can afford to pick up some additional business, because the
company is operating at 75 percent of practical capacity.
Sales revenue............................................................ $127,000
Less: Sales commissions (10%)..............................
12,700
Less manufacturing costs:
Direct material
$ 29,200
Direct labor
56,000
Variable manufacturing overhead
16,800
Total manufacturing costs

Income before taxes.................................................
Income taxes (40%)...................................................
Net income ............................................................
$114,300
102,000
$ 12,300
4,920
$ 7,380
Note that the fixed manufacturing overhead and fixed corporate administration costs
are not relevant in this decision, because these amounts will remain the same
regardless of what Graydons management decides about the order.
McGraw-Hill/Irwin
Inc.

15- 27

3.
The break-even price is $113,333, computed as follows:

Let P = break-even bid price
P 0.1P - $102,000 = 0
0.9P = $102,000
P = $113,333
Income taxes can be ignored, because there is no tax at the break-even point.
4.
Profits will probably decline. Graydon originally used a full-cost pricing formula to
derive a $165,000 bid price. A drop in the selling price to $127,000 signifies that the
firm is now pricing its orders at less than full cost, which would decrease
profitability.
Reduced prices could lead to an increase in income if the company is able to
generate additional volume. This situation will not occur here, because the problem
states that Graydon has operated and will continue to operate at 75 percent of
practical capacity.

1.
Target costing is the design of a product, and the processes used to produce it, so
that ultimately the product can be manufactured at a cost that will enable a firm to
make a profit when the product is sold at an estimated market-driven price. This
estimated price is called the target price, the desired profit margin is called the target
profit, and the cost at which the product must be manufactured is called the target
cost.
2.
Value engineering (or value analysis) refers to a cost-reduction and process

improvement technique that utilizes information collected about a product's design
and production processes and then examines various attributes of the design and
processes to identify candidates for improvement efforts.
Value engineering focuses on improving those qualities that the customer
desires, while reducing or eliminating unnecessary moves, queues, setups, and other
such activities that the customer will not pay for. The process is reengineered to
eliminate non-value-added work and thereby enhance the value of the process to the
customer.
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Solutions Manual

3.
Pharsalia Electronics' current profit on sales is 10 percent [($350$315)/$350].

Therefore, the target cost for the new product must be $300 less 10 percent, or $270
[$300 ($300 10%)].
4.
The proposed changes to the just-in-time cell manufacturing process at Pharsalia

Electronics will bring costs down to $266 per unit, which is below the $270 target cost
limit. Adjusted costs under the JIT cell manufacturing process are calculated as
follows:
Current
Increase/
(Decrease)
Revised
Material:
Purchased components..................................
All other............................................................
$110
40
Labor:
Manufacturing, direct......................................
Setups...............................................................
Material handling.............................................
Inspection.........................................................
65
9
18
23
$ 15
(9)
(18)
(23)
80
0
0
0
Machining:
All......................................................................
35
(5)
30
Other:
Finished-goods warehousing.........................
Warranty*..........................................................
5
10
(5)
(4)
0
6
Total JIT Cost.........................................................
$315
$(49)
$266
$110
40
*40% reduction
McGraw-Hill/Irwin
Inc.

15- 29

1.
(a) Time charges:

Hourly labor cost +
annual overhead (excluding

material handling and storage)
annual labor hours
= $16 +
$108,000
12,000
hourly charge to
cover profit magin
+ $4
= $29 per labor hour

(b) Material charges:
Material cost material cost material handling and storage costs
incurred on job incurred on job annual cost of materials used

Material cost
material cost
$25,000
= incurred on job incurred on job $250,000
2.
PRICE QUOTATION
Time charges:
Labor time ...................................................................................................

400 hours
Rate ..........................................................................................................
$29 per hour
Total .............................................................................................................
$11,600
Material changes: Cost of materials for job ............................................................................

$60,000
+ Charge for material handling and storage ............................................
6,000*
Total .............................................................................................................
$66,000
Total price of job: Time .............................................................................................................
$11,600
Material ........................................................................................................
66,000
Total .............................................................................................................
$77,600
*Charge for material handling and storage):
10% = $25,000 $250,000; 10% $60,000 = $6,000
McGraw-Hill/Irwin
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Solutions Manual

3.
Price of job without markup on material costs (from requirement 2) ....

Markup on total material costs ($66,000 10%) ......................................
Total price of job .........................................................................................
$77,600
6,600
$84,200

1.
Gargantuan Industries should price the standard compound at $22 per case and the
commercial compound at $30 per case. The contribution margin is the highest at
these prices as shown in the following calculations:
Standard Compound
Selling price per case ................................................................................
$18 $20 $21
Variable cost per case ................................................................................
16 16 16
Contribution margin per case ...................................................................
$2 $4 $5
Volume in cases (in thousands) ................................................................
120 100 90
Total contribution margin (in thousands) .................................................
$240 $400 $450
$22
16
$6
80
$480
$23
16
$7
50
$350
Commercial Compound
Selling price per case ................................................................................
$25 $27 $30
Variable cost per case ................................................................................
21 21 21
Contribution margin per case ...................................................................
$4 $6 $9
Volume in cases (in thousands) ................................................................
175 140 100
Total contribution margin (in thousands) .................................................
$700 $840 $900
$32
21
$11
55
$605
$35
21
$14
35
$490
McGraw-Hill/Irwin
Inc.

15- 31

2.
a. Gargantuan Industries should continue to operate during the final six months of
the current year because any shutdown would be temporary. The company
intends to remain in the business and expects a profitable operation during the
next year. This is a short-run decision problem. Therefore, the fixed costs are
irrelevant to the decision, because they cannot be avoided in the short run. The
products do have a positive contribution margin so operations should continue.
GARGANTUAN INDUSTRIES
BOISE PLANT
PROJECTED CONTRIBUTION MARGIN
FOR THE SIX-MONTH PERIOD ENDING DECEMBER 31
(IN THOUSANDS)
Standard Commercial
Sales ............................................................................................................
$1,150
$1,225
Variable costs:
Selling and administrative .....................................................................
$200
$245
Manufacturing .........................................................................................
600
490
Total variable costs ............................................................................
$800
$735
Contribution margin ...................................................................................
$350
$490
Total
$2,375
$ 445
1,090
$1,535
$ 840
b. Gargantuan Industries should consider the following qualitative factors when

making the decision about the Boise Plant.
The effect on employee morale.
The effect on market share.
The disruption of production and sales due to a shutdown.
The effect on the local community.
McGraw-Hill/Irwin
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Solutions Manual

1.
The minimum price per blanket that Omaha Synthetic Fibers, Inc. could bid without
reducing the companys net income is $24 calculated as follows:
Raw material (6 lbs. @ $1.50 per lb.) .........................................................
Direct labor (.25 hrs. @ $7.00 per hr.) .......................................................
Machine time ($10.00 per blanket) ............................................................
Variable overhead (.25 hrs. @ $3.00 per hr.) .............................................
Administrative costs ($2,500 1,000) .......................................................
Minimum bid price ..................................................................................
2.
Using the full cost criteria and the maximum allowable return specified, Omaha
Synthetic Fibers, Inc.s bid price per blanket would be $29.90 calculated as follows:
Relevant costs from requirement (1) ........................................................
Fixed overhead (.25 hrs. @ $8.00 per hr.) .................................................
Subtotal ...................................................................................................
Allowable return (.15 $26) ......................................................................
Bid price ..................................................................................................
3.
$9.00
1.75
10.00
.75
2.50
$24.00
$24.00
2.00
$26.00
3.90
$29.90
Factors that management should consider before deciding whether to submit a bid
at the maximum acceptable price of $25 per blanket include the following:
The company should be sure there is sufficient excess capacity to fill the order
and that no additional investment is necessary in facilities or equipment that
would increase fixed costs.
If the order is accepted at $25 per blanket, there will be a $1 contribution per
blanket to fixed costs. However, the company should consider whether there are
other jobs that would make a greater contribution.
Acceptance of the order at a low price could cause problems with current
customers who might demand a similar pricing arrangement.
McGraw-Hill/Irwin
Inc.

15- 33

1.
Budgeted overhead costs:

Department I Department II
Variable overhead
$300,000
Department I: 37,500 $8 .....................................................................
Department II: 37,500 $4 .....................................................................
Fixed overhead ...........................................................................................
150,000
Total overhead ............................................................................................
$450,000
Total budgeted overhead for both
departments ($450,000 + $300,000) .........................................................
Total expected direct-labor hours for
both departments (37,500 + 37,500) ........................................................
Predetermined overhead rate =
=
$150,000
150,000
$300,000
$750,000
75,000
budgeted overhead
budgeted direct -labor hours
$750,000
75,000
= $10 per direct-labor hour

2.
3.
Basic
Total cost ....................................................................................................
$400
Markup (15% of cost)
60
Basic: $400 .15 ...................................................................................
Advanced: $500 .15 .............................................................................
Price ............................................................................................................
$460
Advanced
$500
75
$575
Department I Department II
Budgeted overhead (from requirement 1).................................................
$450,000
$300,000
Budgeted direct-labor hours .....................................................................
37,500
37,500
$450,000
$300,000
Calculation of predetermined overhead rate ............................................
37,500
37,500
Predetermined overhead rate ....................................................................

$12
$8
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Solutions Manual

4.
5.
6.
Basic
Direct material ............................................................................................
$160
Direct labor .................................................................................................
140
Manufacturing overhead:
Department I:
24
Basic: 2 $12 .....................................................................................
Advanced: 8 $12 ..............................................................................
Department II:
64
Basic: 8 $8 .......................................................................................
Advanced: 2 $8 ................................................................................
Total cost ....................................................................................................
$388
Advanced
$260
140
Basic
Total cost (from requirement 4)..................................................................
$388.00
Markup (15% of cost)
58.20
Basic: $388 .15 ....................................................................................
Advanced: $512 .15 .............................................................................
Price ............................................................................................................
$446.20
Advanced
$512.00
96
16
$512
76.80
$588.80
The management of Sounds Fine, Inc. should use departmental overhead rates. The
overhead cost structures in the two production departments are quite different, and
departmental rates more accurately assign overhead costs to products. When the
company used a plantwide overhead rate, the Basic speakers were overcosted and the
Advanced speakers were undercosted. This in turn resulted in the Basic model being
overpriced and the Advanced model being underpriced. The cost and price distortion
resulted from the following facts: (1) the Basic speakers spend most of their
production time in Department II, which is the least costly of the two departments; and
(2) the Advanced speakers spend most of their production time in Department I, which
is more costly than Department II.
McGraw-Hill/Irwin
Inc.

15- 35

1.
Bid based on standard pricing policy:

Direct material ...........................................................................................
Direct labor (11,000 DLH @ $15) ..............................................................
Manufacturing overhead (11,000 DLH @ $9) ...........................................
Full manufacturing costs .....................................................................
Markup (50% of full cost) .........................................................................
Standard pricing policy bid ......................................................................
2.
$256,000
165,000
99,000
$520,000
260,000
$780,000
Minimum bid acceptable to Zylar:

Direct material ...........................................................................................
Direct labor (11,000 DLH @ $15) ..............................................................
Variable manufacturing overhead (11,000 @ $5.40a) ..............................
Opportunity cost of lost salesb .................................................................
Minimum bid ..............................................................................................
a
Proportion of variable overhead
budgeted variable overhead

budgeted total overhead
$972,000
$1,620,000
$256,000
165,000
59,400
35,200
$515,600
= 60%
variable
total overhead
rate
overhead proportion
Variable overhead rate =
= ($9.00) (.6)
= $5.40
McGraw-Hill/Irwin
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Solutions Manual

b
Selling price per unit of standard product...............................................

Variable costs per unit
Direct material .....................................................................................
$2,500
Direct labor (250 DLH @ $15) .............................................................
3,750
Variable overhead (250 DLH @ $5.40) ...............................................
1,350
Net contribution per unit ............................................................................
36,000 DLH
Standard product requirements (12,000 DLH 3) ...................................
Special order requirements .......................................................................
11,000 DLH
Total hours required ...................................................................................
47,000 DLH
45,000 DLH
Plant capacity per quarter (15,000 DLH 3) ............................................
Shortage in hours .......................................................................................
2,000 DLH
Lost unit sales (2,000 DLH 250 DLH) .....................................................
Lost contribution ........................................................................................
$12,000
7,600
$4,400
8
$35,200
Lyan Companys assistant purchasing manager is not acting ethically. The details
of the bid submitted by Zylar Industries are confidential between Zylar Industries and
Lyan Company. It is unfair and unethical to give this information to Zylars
competitor. If Lyan Company had wanted competing bids on the specialized
equipment, the bids should have been solicited at the same time from the relevant
set of manufacturers. Each competing firm should receive the same specifications
on the customized equipment and be given the same time frame in which to
complete the bid. Moreover, the competing firms should be made aware that more
than one bid is being solicited.
McGraw-Hill/Irwin
Inc.

15- 37

1.
The lowest price Biloxi Corporation would bid for a one-time special order of 25,000
pounds (25 lots) would be $34,750, which is equal to the variable costs of the order
calculated as follows:
(a) Direct material:
On a one-time only special order, chemicals used in manufacturing the firms
main product have a relevant cost of their expected future cost, represented by
the current market price per pound. Chemicals not used in current production
have a relevant cost of their value to the firm.
RH-3: (400 pounds per lot) (25 lots) = 10,000 pounds.
Substitute CN-5 on a one-for-one basis to its total of 5,500
pounds. The relevant cost is the salvage value. ...............................
$500
The remaining 4,500 pounds would be RH-3 at a relevant cost of

$.90 per pound, its expected future cost. ...........................................
4,050
JX-6: (300 pounds per lot) (25 lots) = 7,500 pounds at

$.60 per pound. ....................................................................................
4,500
MZ-8: (200 pounds per lot) (25 lots) = 5,000 pounds at

$1.60 per pound. ..................................................................................
8,000
BE-7: (100 pounds per lot) (25 lots) = 2,500 pounds.

The relevant cost per pound is $.65 $.10 (handling charge) = $.55.
The amount the company could realize by selling BE-7. is 2,500
pounds at $.55 per pound............................................................ 1,375
$18,425
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Solutions Manual

(b) Direct labor:
(60 DLH per lot) (25 lots) = 1,500 direct-labor hours (DLH)
Because only 800 hours can be scheduled during regular time this month,
overtime would have to be used for the remaining 700 hours; therefore, overtime
is a relevant cost of this order.
$10,500
(1,500 DLH) ($7.00 per DLH) ...................................................................................
2,450
(700 DLH) ($3.50 per DLH) ......................................................................................
Total direct-labor cost ................................................................................................
$12,950
(c) Overhead:
This special order will not increase fixed overhead costs. Therefore, fixed
overhead is not relevant, and the relevant overhead charge is the variable
overhead rate:
3,375
(1,500 DLH) ($2.25 per DLH) = ................................................................................
Total cost of special order .........................................................................................
$34,750*
*$34,750 = $18,425 + $12,950 + $3,375
2.
Calculation of the price for recurring orders of 25,000 pounds (25 lots) is as follows.
(a) Direct material:
Because of the possibility of future orders, raw materials must all be charged at
their expected future cost represented by the current market price per pound.
RH-3: (10,000 pounds)
($.90 per pound) ...............................................................................
$9,000
JX-6: (7,500 pounds)

($.60 per pound) .............................................................................
.............................................................................................................. )
4,500
MZ-8: (5,000 pounds)

($1.60 per pound) ...........................................................................
8,000
BE-7: (2,500 pounds)

McGraw-Hill/Irwin
Inc.
1,625
15- 39
($.65 per pound) .............................................................................

$23,125
(b) Direct labor:
60% of the production of a batch (900 DLH) can be done on regular time; the
remaining 600 DLH cause overtime to be incurred and are a relevant cost of this
new product.
Regular time
$10,500
(1,500 DLH) ($7.00 per DLH) .................................................................................
Overtime premium
2,100
(600 DLH) ($3.50 per DLH) ....................................................................................
Total direct-labor cost ................................................................................................
$12,600
(c) Overhead:
All new products should contribute to fixed overhead as well as cover all variable
costs and provide a markup. Therefore, the overhead charge would be:
$9,000
(1,500 DLH) ($6.00 per DLH) ...................................................................................
(d) Markup and price calculation:
Full manufacturing cost .............................................................................................
$44,725 *
Markup (25%) ..............................................................................................................
11,181
Full manufacturing cost plus 25% markup ..............................................................
$55,906
*$44,725 = $23,125 + $12,600 + $9,000
Rounded.
3.
The owner of Taylor Nursery is not acting ethically in this situation. It is

inappropriate to allow Biloxi Corporation to revise its bid on the basis of confidential
information included in the details of the Dalton Industries bid. All firms competing
for the Taylor Nursery contract should be given the same product specifications,
information, and time frame with which to prepare a bid.
McGraw-Hill/Irwin
Inc.
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Solutions Manual
SOLUTIONS TO CASES
CASE 15-51 (45 MINUTES)
1.
The total sales price can be determined by the following formula:

Let S = IC + T + NIAT
Where S = total price
IC = incremental cost
T = taxes
T = (S IC)t
t = tax rate
NIAT = net income after taxes
NIAT = S desired return on total price
Substituting for the known items, the formula is revised to read:
S = IC + (S IC) .4 + .10S
The incremental costs for the three-year order are calculated as shown in the
following schedule.
McGraw-Hill/Irwin
Inc.

15- 41
CASE 15-51 (CONTINUED)
Cost Item
Direct material
Direct labor
Indirect labor
Supplies
Additional supplies
Power
Additional power
Factoryadministration
Depreciation
Sales commission
Total incremental costs
Current
Amounts
(in thousands)
$200
400
100
40
120
60
70
Contract
Increase
10%
10%
10%
$4
10%
$10
$15*
$10
Inflation
Rate
5%
10%
10%
10%
20%
20%
10%
Years
3
3
3
3
3
3
3
Details of
Calculations
(200 .10 1.05 3)
(400 .10 1.10 3)
(40 .10 1.10 3)

(4 1.10 3)
(120 .10 1.20 3)
(10 1.20 3)
(15 1.10 3)
Amount
(in
thousands)
$63.0
132.0
13.2
13.2
43.2
36.0
49.5
10.0
$360.1
*The current amount of factory administration, $60,000, will be unchanged, but an additional part-time factory
supervisor will be hired at an annual cost of $15,000.
The company has idle capacity that will be fully utilized by this order. The capacity costs (i.e., depreciation) would be
expensed whether management accepted the order or not. Therefore, the depreciation is a sunk cost and is not
considered an incremental cost of the order.
McGraw-Hill/Irwin
15-42
2002 The McGraw-Hill Companies, Inc.

Solutions Manual

The total price needed by Polaski for the three-year order is $432,120 as shown in the
calculations below:
S = IC + (S IC) .4 + .10S
S = $360,100 + (S $360,100).4 + .10S
S = $360,100 + .4S $144,040 + .10S
.5S = $216,060
S = $432,120
2.
If the three-year order is to contribute nothing to net income after taxes, Polaski
would set the total price at $360,100, an amount equal to the incremental costs to
produce the order.
CASE 15-52 (60 MINUTES)

Memorandum
Date:
Today
To:
President, CPI
From:
I.M. Student
Subject: Convention fee

CPI can maximize its contribution from its annual convention by charging a single, flat fee
of $300. Using this fee structure, CPIs contribution will be $400,925 as shown by the
detailed calculations for the separate pricing option and the three single, flat fee options
that follow.
Pricing Option
Separate pricing
Flat fee options:
$325
300
275
McGraw-Hill/Irwin
Inc.
Contribution
$374,200
400,100
400,925
387,550

15- 43

(a) Contribution analysis for separate pricing
(estimated hotel registrations = 60% 2,000 = 1,200):
Function
Registration ........................
Reception ............................
Annual meeting* .................
Keynote luncheon ..............
Six concurrent sessions* ...
Plenary session* .................
Six workshops ....................
Banquet ...............................
Hotel credit for free rooms
1,200
50
Estimated
Attendance
100% 2,000 = 2,000
100% 2,000 = 2,000
100% 2,000 = 2,000
90% 2,000 = 1,800
70% 2,000 = 1,400
70% 2,000 = 1,400
50% 2,000 = 1,000
90% 2,000 = 1,800
Revenue
$100,000
-0-072,000
84,000
70,000
100,000
90,000
Expense
$-0-
50,000
-0-*
45,000
-0-*
-0-*
-0-*
54,000
Contribution
$100,000
(50,000)
-0-
27,000
84,000
70,000
100,000
36,000
$125 .8 3
Total .....................................
(7,200)
$516,000 $141,800
7,200
$374,200
*Meeting rooms and halls are free when 1,000 members are expected to register at the hotel.
Reflects 20% discount.
McGraw-Hill/Irwin
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Solutions Manual

(b) Contribution analysis for flat fee pricing.
$325
Fee
1,600
960
Number of attendees (given)

Estimated hotel registrations (60%)
Number of free rooms
(registration divided by 50, with
no fractional credit)
19
$520,000
Revenue (fee attendees)
Expenses
$40,000
Reception ($25 100% attendees)
Annual meeting*
2,000
Keynote luncheon ($25 90% attendees) 36,000
Six concurrent sessions*
1,200
Plenary session*
2,000
Six workshops
1,200
43,200
Banquet ($30 90% attendees)
Total expenses
$125,600
Revenue less expenses
$394,400
5,700
Room credit ($300 free rooms)
Contribution
$400,100
$300
Fee
1,750
1,050
$275
Fee
1,900
1,140
21
$525,000
22
$522,500
$43,750
-039,375
-0-0-047,250
$130,375
$394,625
6,300
$400,925
$47,500
-042,750
-0-0-051,300
$141,550
$380,950
6,600
$387,550
*Meeting rooms and halls are free when 1,000 members are expected to register at
the hotel.
Reflects 20% discount.
McGraw-Hill/Irwin
Inc.

15- 45
CURRENT ISSUES IN MANAGERIAL ACCOUNTING

ISSUE 15-53
HIGH FUEL PRICES MAY HURT STORES, NOT CONSUMERS," THE WALL STREET
JOURNAL, SEPTEMBER 28, 2000, DANIEL MACHALABA AND REBECCA QUICK.
1. Retailers will absorb increased shipping costs instead of passing them along to
customers for the holiday season discussed in this article. The highly competitive
nature of the season determines that the cost of retail goods will be determined by
market-based pricing.
2. Cost-based pricing is when sellers determine their costs and add a profit margin.
Market-based pricing is when a competitive price is determined at which the product
will sell. As mentioned above, market-based pricing is likely to prevail in this
scenario.
ISSUE 15-54
CAR MAKERS MAY TRY TO ALTER PRICING PRACTICES," THE WALL STREET JOURNAL,
JANUARY 24, 2000, JOSEPH B. WHITE AND FARA WARNER.
U. S. auto dealers are changing their pricing policies as a result of the surge in online
auto trading by adjusting their online prices on a daily basis. A growing number of
dealers already are abandoning the practice of negotiating down from an MSRP, as more
consumers come to showrooms armed with invoice price information downloaded from
the internet.
McGraw-Hill/Irwin
Inc.
15-46

Solutions Manual
ISSUE 15-55
AUTO MAKERS BOOST CHARGES FOR SHIPPING NEW CARS BECAUSE OF HIGHER
FUEL COSTS," THE WALL STREET JOURNAL, OCTOBER 25, 2000, SHOINN
FREEMAN.
1. The issue involved in the decision to pass on to consumers the higher prices of fuel
costs are increased pressure on profit margins as real prices for new cars actually
decline.
2. As all auto makers feel the decline in profits, cost-based pricing takes priority across
the industry. Without profits the auto industry cannot stay in business, and therefore
all makers have to raise prices. The auto makers do not have to compete against each
other on an unbalanced price-competitive field.
ISSUE 15-56
VOLKSWAGEN AG PLANS ONLINE SUPPLY MARKET IN MOVE TO CUT COSTS," THE
WALL STREET JOURNAL, APRIL 13, 2000.
In a competitive bidding situation, two or more companies submit sealed bids for a
product, service, or project to a buyer. The buyer selects one of the companies for the
job on the basis of the bid price and the design specifications for the job. Volkswagen
hopes to take the lead in establishing a European Internet-supply network. Although
the supply network could result in competitive bidding, its focus will be on the efficiency
of the supply chain.
ISSUE 15-57
CHANGING CODE: FOR POLICY MAKERS, MICROSOFT SUGGESTS NEED TO RECAST
MODELS - AGENCIES SCRAMBLE AS WEB POSES GOOD MONOPOLIES, SKEWS
CLASSIC ECONOMICS - AVALANCHE VS. THERMOSTAT, " THE WALL STREET
JOURNAL, JUNE 9, 2000, ALAN MURRAY.
1. Several car manufacturers recently joined together to form a single linked exchange
that big auto companies will use for purchasing parts. The combined purchasing
platform is being done so the auto industry can have standards. The end result will
be more competition.
McGraw-Hill/Irwin
Inc.

15- 47
2. In information businesses, the desire for everyone to be part of the same network is
intense. This is the network effect.
ISSUE 15-58
TARGET COSTING CAN BOOST YOUR BOTTOM LINE, " STRATEGIC FINANCE, JULY 1999,
GERMAIN BOER AND JOHN ETTLIE.
Using the bottom-up approach engineers can add the estimated prices of purchased
components and estimated production costs for each part that goes into a new product.
Databases containing current component purchase prices, product routings, and bills of
material for existing parts enable design engineers to estimate the cost of new parts.
Another approach is to deduct the desired margin for a product from the predicted
selling price. This approach is consistent with the Japanese concept of price-down,
cost-down, which says production costs must decline as the price of a product declines.
In other words, the market determines the acceptable cost for a product.
ISSUE 15-59
MACHINE CIGARETTE VENDORS SUE PHILIP MORRIS ON PRICES," THE WALL STREET
JOURNAL, FEBRUARY 4, 1999.
Price discrimination is when a vendor sells their products at different prices to various
buyers, usually using such techniques as merchant rebates, buybacks and other
promotional fees. Whether the case in question constitutes price discrimination will be
determined by the courts.
ISSUE 15-60
HOW SHOULD WE PRICE OUR PRODUCTS? "
HEINTZELMAN.
CONVERTING, AUGUST 2000, SKIP
The article discusses several methods of pricing products, including full-cost coverage,
marking up material cost, marking up full factory cost, and marking up conversion cost.
According to the article, marking up material costs to price products will tend to
encourage jobs using low-priced materials and penalize products requiring higherpriced materials.
McGraw-Hill/Irwin
Inc.
15-48

Solutions Manual

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CHAPTER 15

Target Costing and Cost Analysis for Pricing

Four major influences on pricing decisions are as follows:

It is crucial to define the firms product when considering the reaction of

2002 The McGraw-Hill Companies,

(a) Total revenue: Price multiplied by quantity sold.

(a) Total cost: Unit cost multiplied by quantity produced.

Three limitations of the economic, profit-maximizing model of pricing are as follows:

2002 The McGraw-Hill Companies,

15.11 The general formula for cost-plus pricing is as follows:

2002 The McGraw-Hill Companies,

2002 The McGraw-Hill Companies,

2002 The McGraw-Hill Companies,

Tabulated price, quantity, and revenue data:

*Column (1) times column (2).

Differences between amounts in column (3).

2002 The McGraw-Hill Companies,

EXERCISE 15-28 (CONTINUED)

Total revenue curve:

2002 The McGraw-Hill Companies,

EXERCISE 15-29 (30 MINUTES)

Tabulated cost and quantity data:

*Column (1) times column (2).

Differences between amounts in column (3).

2002 The McGraw-Hill Companies,

EXERCISE 15-29 (CONTINUED)

Total cost increases

Total cost increases

2002 The McGraw-Hill Companies,

2002 The McGraw-Hill Companies,

EXERCISE 15-30 (40 MINUTES)

Tabulated revenue, cost, and profit data:

*Column (1) times column (2).

**Column (3) minus column (4).

Total revenue and cost curves: see next page.

2002 The McGraw-Hill Companies,

EXERCISE 15-30 (CONTINUED)

Total revenue and cost curves:

Total profit at the profitmaximizing quantity and

2002 The McGraw-Hill Companies,

EXERCISE 15-31 (25 MINUTES)

Total profit at profit-maximizing quantity and price

Quantity sold per

Demand (average revenue)

2002 The McGraw-Hill Companies,

EXERCISE 15-32 (15 MINUTES)

Profit on sales of 60,000 units:

p denotes Argentinas peso

Required price on special order:

target additional profit

unit variable cost + required unit

2002 The McGraw-Hill Companies,

EXERCISE 15-33 (30 MINUTES)

total annual costs not

total variable selling and

$60,000 (480 $50) [480 ($250 $100)]

$60,000 $24,000 $168,000

2002 The McGraw-Hill Companies,

EXERCISE 15-34 (CONTINUED)

target profit (given)

total selling and

$60,000 [480 ($50 $100)]

2002 The McGraw-Hill Companies,