Reference no: EM132708097

Problem - Cost-Plus and Target Costing Concepts

The following conversation took place between Dean Lancaster, vice president of marketing, and Dina Conaway, controller of Redwood Computer Company:

Dean: I am really excited about our new computer coming out. I think it will be a real market success.

Dina: I'm really glad you think so. I know that our success will be determined by our price. If our price is too high, our competitors will be the ones with the market success.

Dean: Don't worry about it. We'll just mark our product cost up by 25% and it will all work out. I know we'll make money at those markups. By the way, what does the estimated product cost look like?

Dina: Well, there's the rub, The product cost looks as if it's going to come in at around $1,000. With a 25% markup, that will give us a selling price of $1,250.

Dean: I see your concern. That's a little high. Our research indicates that computer prices are dropping and that this type of computer should be selling for around $900 when we release it to the market.

Dina: I'm not sure what to do.

Dean: Let me see if I can help. How much of the $1,000 is fixed cost?

Dina: About $300.

Dean: There you go. The fixed cost is sunk. We don't need to consider it in our pricing decision. If we reduce the product cost by $300, the new price with a 25% markup would be right at $875. Boy, I was really worried for a minute there. I knew something wasn't right.

Required -

1. If you were Dina, how would you respond to Dean's solution to the pricing problem?

2. How might target costing be used to help solve this pricing dilemma?