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A company is planning a new product. Market research information suggests that the product should sell 10,000 units at $21.00/unit. The company seeks to make a mark-up of 40% product cost. It is estimated that the lifetime costs of the product will be as follows:
1 Design and development costs $50,000
2 Manufacturing costs $10/unit
3 End of life costs $20,000
The company estimates that if it were to spend an additional £15,000 on design, manufacturing costs/ unit could be reduced.
Required
(a) What is the target cost of the product?
(b) What is the original lifecycle cost per unit and is the product worth making on that basis?
(c) If the additional amount were spent on design, what is the maximum manufacturing cost per unit that could be tolerated if the company is to earn its required mark-up?
Solution
The target cost of the product can be calculated as follows:
(a) Cost + Mark-up = Selling price
$15 $6 $21
100% 40% 140%
(b) The original life cycle cost per unit = ($50,000 +(10,000 x $10) + $20,000)/10,000 = $17
This cost/unit is above the target cost per unit, so the product is not worth making.
(c) Maximum total cost per unit = $15. Some of this will be caused by the design and end of life costs:
=($50,000 + $15,000 + $20,000)/10,000
= $8.50
Therefore, the maximum manufacturing cost per unit would have to fall from $10 to ($15 - $8.50)
= $6.50.
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