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Costing, pricing

A Fortune 100 company, Caterpillar is the world's leading manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines. Caterpillar also manufactures custom piston pins for other manufacturers in the same facility used to make pins for its own heavy duty engines. Piston pins are made with cost effective CNC bar feeders and multispindle barstock machines. This process is a high output, high efficiency operation that eliminates the added costs of purchasing special cut to length barstock or cutting barstock to specific lengths.

The market research department has indicated that a proposed new piston pin for a manufacturerof truck engines would likely sell for $46. A similar piston pin currently being produced has the following manufacturing costs:

Direct materials $24.00
Direct labor 10.00
Overhead 16.00
total $50.00

Assume that Caterpillar desires a gross margin of 35% of the manufacturing cost.

1. Suppose Caterpillar used cost-plus pricing, setting the price 35% above the manufacturing cost. What price would be charged for the piston pin? Would you produce such a piston pin if you were a manager at Caterpillar? Explain

2. Caterpillar uses target costing. What price would the company charge for a piston pin? What is the highest acceptable manufacturing cost for which Caterpillar would be willing to produce the piston pin?

3. As a user of target costing, what steps would Caterpillar managers take to try to make production of this product feasible?

Solution Preview

1. Suppose Caterpillar used cost-plus pricing, setting the price 35% above the manufacturing cost. What price would be charged for the piston pin? Would you produce such a piston pin if you were a manager at Caterpillar? Explain

35% of the total manufacturing cost= 35% of $50= $17.50

Therefore, the price charged for the piston pin would be $50+$17.50= $67.50

As a manager at caterpillar, I would be reluctant to produce pins at these cost levels because after our markup, the target selling price of our product would be unacceptable in market because ongoing selling price in the market is $46 only.

2. Caterpillar uses target costing. What price would the company charge for a piston pin? What is the highest acceptable manufacturing cost for which Caterpillar would be willing to produce the piston pin?

The company would charge $46 for the piston pin because market will not accept higher price.
Since Caterpillar desires 35% gross profit markup on cost, the acceptable manufacturing cost will be:

x + 35% of x= $46

x= $34.07.

Therefore, ...

Solution Summary

Costing, pricing

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