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Accounting: Target Costing

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Rainbow Cruises operates a week-long cruise tour through the Hawaiian Islands. Passengers currently pay $1,500 for a two-person cabin, which is an all-inclusive price that includes food, beverages, and entertainment. The current cost to Rainbow per two-person cabin is $1,200 for the week-long cruise, and at this cost, Rainbow is able to earn the minimum profit margin needed to operate the business. Rainbow competes with two other cruise lines and, to date, $1,500 has been the prevailing market price for the week-long cruises. Each cruise line provides exactly the same services to their passengers, but recently, one of Rainbow's competitors has found a way to permanently lower its price to $1,250 per two-person cabin.

Required:

a) At a new market price of $1,250 per two-person cabin, calculate the target cost that will allow Rainbow to earn the same profit margin percentage it currently earns.
b) Calculate the target cost reduction that Rainbow must achieve if it expects to remain competitive.
c) Describe several cost reduction initiatives that Rainbow might explore to achieve its target cost reduction requirements.

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