On Point, Inc., is interested in producing and selling a deluxe electric pencil

Question

On Point, Inc., is interested in producing and selling a deluxe electric pencil sharpener. Market research indicates that customers are willing to pay $40 for such a sharpener and that 20,000 units could be sold each year at this price. The cost to produce the sharpener is currently estimated to be $34. a. If On Point requires a 16 percent return on sales to undertake production of a product, what is the target cost for the new pencil sharpener? b. If a competitor sells basically the same sharpener for $36, what would On Point's target cost be to maintain a 16 percent return on sales? HELP

Explanation / Answer

This can be solved algebraically:

a.) Selling price per unit is $40. Estimated units sold is 20,000.
Estimated revenue = $40 x 20,000 units = $800,000

We want to achieve a 16% return (i.e. profit) on sales. In other words:
(Revenue - Costs)/Revenue = 16%

Solve for target costs (x):
$800,000 - x = .16($800,000)
$800,000 - x = $128,000
x = $672,000
Target Cost per unit = $672,000/20,000 = $33.60

b.) Assuming our competitor sells theirs for $36, we will most likely want to match that selling price. So:

Estimated revenue = $36 x 20,000 = $720,000

Solve for target costs (x):
$720,000 - x = .16($720,000)
$720,000 - x = $115,200
x = $604,200
Target Cost per unit = $604,200/20,000 = $30.24

Hope that helps. Please rate.

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