Task: 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.
Question 1. Compute the expected profit over the entire product life cycle of the proposed riding lawn mower.
Question 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?
Question 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?