Problem:
Baker, Inc., produces a number of components that are used in home theater systems. Fred Briggs, head of the company's market research department, has identified the need for a new component that will most likely sell for $75. Projected volume levels are anticipated to reach 28,000 units in the first year, as several firmly entrenched competitors will be introducing a similar product in the not-too-distant future.
Conversations with Baker's engineers and reviews of cost accounting data related to similar products that the company manufactures resulted in the following cost estimates for the new component:
Direct Materials $18
Direct Labor $36
Manufacturing Overhead $16
Selling and Administrative $5
Baker currently uses cost-plus pricing and adds a 20% markup on total production cost to arrive at what is normally a competitive selling price.
Required:
A. What is the anticipated selling price of the new component if Baker uses its current pricing policy? What difficulties, if any, might the company face in the marketplace?
B. Assume that Baker decides to switch to target costing. What price would the company charge for the new component?
C. With the switch to target costing, what would Baker have to do to the component's manufacturing cost to achieve the normal profit margin on sales? Be specific and show calculations.
D. Briefly describe a process that Baker can use to achieve your answer in requirement "C."