MPE, Inc. will soon enter a very competitive marketplace in which it will have limited influence over the prices that are charged. Management and consultants are currently working to fine-tune the company's sole service, which hopefully will generate a 12 percent first-year return (profit) on the firm's $18,000,000 asset investment. Although the normal return in MPE's industry is 14 percent, executives are willing to accept the lower figure because of various start-up inefficiencies. The following information is available for first-year operations:
Hours of service to be provided: 25,000
Anticipated variable cost per service hour: $22
Anticipated fixed cost: $1,900,000 per year
Required:
1. Assume that management is contemplating what price to charge in the first year of operation. The company can take its cost and add a markup to achieve a 12 percent return; alternatively, it can use target costing. Given MPE's marketplace, which approach is probably more appropriate? Why?
2. How much profit must MPE generate in the first year to achieve a 12 percent return?
3. Calculate the revenue per hour that MPE must generate in the first year to achieve a 12 percent return.
4. Assume that prior to the start of business in year 1, management conducted a planning exercise to determine if MPE could attain a 14 percent return in year 2. Can the company achieve this return if (a) competitive pressures dictate a maximum selling price of $175 per hour and (b) service hours and the variable cost per service hour are the same as the amounts anticipated in year 1? Show calculations.
5. If your answer to requirement (4) is no, suggest and briefly describe a procedure that MPE might use to achieve the desired results.