# Target costing vs

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```					ACCY 302                                             University of Illinois at Urbana-Champaign

Target costing vs. Target pricing
1. Marklee Industries makes electric motors for a variety of small appliances. It
sells the motors to manufacturers that assemble and sell the appliances. The
company’s market research department has discovered a market for electric
motors used for trolling in small fishing boats, which Marklee presently does not
produce. The market research department has indicated that mors likely would
sell for \$46 each. A similar motor currently being produced has the following
manufacturing costs:

Direct materials      \$24
Direct labor           10
Total                 \$42

Assume that Marklee desires an operating profit margin of 10 percent.

a. Suppose that Marklee uses cost-plus pricing, setting the price 10% above the
manufacturing cost. What price should it charge for the motor?
b. Suppose that Marklee uses target costing. What price should it charge for a
trolling motor? What is the highest acceptable manufacturing cost for which
Marklee would be willing to produce the motor?
c. Would you produce such a motor if you were a manager at Marklee? Explain.

Transfer pricing
2. The Glass Division of Sonnet, Inc., manufactures a variety of glasses and vases for
household use. The vases can be sold externally or internally to Sonnet’s Florist
Division. Sales and cost data on a basic ten-inch vase are given below:

Unit selling price                   \$2.50
Unit variable cost                   \$1.10
Unit product fixed cost*             \$0.50
Practical capacity in units        500,000

*\$250,00/500,000

During the coming year, the Glass Division expects to sell 350,000 units of this
vase. The Florist Division currently plans to buy 150,000 vases on the outside market for
\$2.50 each. Neil Harper, manager of the Glass Division, approached Martha Strahorn,
manager of the Florist Division, and offered to sell the 150,000 vases for \$2.45 each.
Neil explained to Martha that he can avoid selling costs of \$0.10 per vase by selling
internally and that he would split the savings by offering a \$0.05 discount on the usual
price.

Required
1. What is the minimum transfer price that the Glass Division would be willing to
accept? What is the maximum transfer price that the Florist Division would be
ACCY 302                                            University of Illinois at Urbana-Champaign

willing to pay? Should an internal transfer take place? What would be the benefit
(or loss) to the firm as a whole if the internal transfer takes place?
2. Suppose Martha knows that the Glass Division has idle capacity. Do you thin that
she would agree to the transfer price of \$2.45? Suppose she counters with an
offer to pay \$2.00. If you were Neil, would you be interested in this price?
Explain with supporting computations.
3. Suppose that Sonnet, Inc., policy is that all internal transfers take place at full
manufacturing cost. What would the transfer price be? Would the transfer take
place?

Constrained Optimization and the T.O.C.
2. Jackson Enterprises makes and sells three types of stuffed toys. Management is
trying to determine the most profitable mix. Sales prices, demand, and use of
manufacturing inputs follow:
Bears           Cows          Dogs
Sales price                           \$15             \$32           \$95
Annual demand (units)                 20,000          10,000        30,000
Input requirement per unit
Direct material               .5 yards        .3 yards      .6 yards
Direct labor                  .7 hours        2 hours       7 hours
Costs
Variable costs
Materials             \$10 per yard
DL                       8 per hour
OH                       2 per dl-hr.
Marketing             10% of sales price
Annual fixed costs
Manufacturing         \$18,000
Marketing                4,000
The company faces two limits: (1) the volume of stuffed toys that it can sell and
(2) 30,000 direct labor-hours per year caused by the plant layout.

a. How much operating profit could the company earn if it were able to satisfy
the annual demand?
b. Which of the three product lines makes the most profitable use of the
constrained resource, direct labor?
c. Given the information in the problem so far, what product mix do you
recommend?
d. How much operating profit should your recommended product mix generate?
e. Suppose that the company could expand its labor capacity by running an extra
shift that could provide up to 10,000 more hours. The cost would increase
from \$8 to \$9.50 per hour. What additional product(s) should Jackson
manufacture and what additional profit would be expected with the use of the