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Target Costing Over Product Life Cycle

Target Costing Over Product Life Cycle

Southeast Equipment makes a variety of motor-driven products for homes and small businesses. The
market research department recently identified power lawn mowers as a potentially lucrative market.
As a first entry into this market, Southeast is considering a riding lawn mower that is smaller and less
expensive than those of most of the competition. Market research indicates that such a lawn mower
would sell for about $995 at retail and $800 wholesale. At that price, Southeast expects life-cycle sales
as follows:

Year Sales

2004 ____ 1,000
2005 ____ 5,000
2006 ____ 10,000
2007 ____ 10,000
2008 ____ 8,000
2009 ____ 6,000
2010 ____ 4,000

The production department has estimated that the variable cost of production will be $475 per
lawn mower, and annual fixed costs will be $900,000 per year for each of the 7 years. Variable selling
costs will be $25 per lawn mower and fixed selling costs will be $50,000 per year. In addition, the
product development department estimates that $5 million of development costs will be necessary to
design the lawn mower and the production process for it.

1. Compute the expected profit over the entire product life cycle of the proposed riding lawn mower.

2. Suppose Southeast expects pretax profits equal to 10% of sales on new products. Would the company
undertake production and selling of the riding lawn mower?

3. Southeast Equipment uses a target costing approach to new products. What steps would management
take to try to make a profitable product of the riding lawn mower?

Solution Preview

1. Total expected profit over the life cycle = Total income over the life cycle - Total cost over the life cycle
Total income over the life cycle = Total unit sales X price per unit
Total unit sales = 44,000
Price per unit = $800 (wholesale since this is what is received by the company)
Total revenue = 44,000 X 800 = ...

Solution Summary

The solution explains calculations relating to Target Costing Over Product Life Cycle

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