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    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?

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    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

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