LeeWays Consulting Company is about to enter a very competitive market and will have little influence on prices that they can charge. LeeWays objective is hoping to generate a 14 percent first-year return (profit) on the firm's investment of $15,000,000. Although the return on investment in the consulting service industry is typically 20%, management at LeeWay is willing to accept a lower rate of return (14%) because of various start-up inefficiencies.
The following information is available for year one operation:
Hours of consulting service to be provided $30,000
Anticipated fixed cost per year $2,500,000
Anticipated variable cost per service hour $40.00
1. Management is deciding what hourly consulting fee to charge in it's first year of operations. LeeWays has two options:
a) Take its cost and added a markup of 14 percent, or
b) Use target costing to determine its hourly consulting fee
Given the marketplace LeeWays is operating in, which option is more appropriate? Why?
2. How much profit must LeeWays earn in the first year of operation to reach a 14% return?
3. compute the revenue (consulting fee) per hour that LeeWays must generate in the first year of operations to achieve a 14% return?
4. assume that management conducted a planning exercise before the start of business in year one to determine if, in year 2 LeeWays could earn an 18% return. Can LeeWays achieve the year 2 return of 18% if:
a) Competitive pressures dictate a maximum consulting fee of $200 per hour and,
b) The variable cost per service hour remains unchanged at $40.00 per hour and,
c) Service hours are the same (25,000) as the amounts anticipated in year one.
The LeeWays consulting investments.