Target Costing (LO3)

Redback Networks, Inc., a subsidiary of Ericsson, provides networking services and related systems for 75% of the world’s largest telephone companies. Assume that it is developing a new networking system for smaller, private telephone companies. To attract small companies, Redback must keep the price low without giving up too many of the features of larger networking systems. A marketing research study conducted on the company’s behalf found that the price range must be $50,000 to $75,000. Management has determined a target price to be $60,000. The company’s minimum profit percentage of sales is normally 20 percent, but the company is willing to reduce it to 15 percent to get the new product on the market. The fixed costs for the first year are anticipated to be $8,000,000. If sales reach 500 installed networks, the company needs to know how much it can spend on variable costs, which are primarily related to installation. ;

Required

a. What is the amount of total cost allowed if the 15 percent profit target is allowed and the sales target is met? Show the amount for fixed and for variable costs.

b. What is the amount of total costs allowed if the 20 percent normal profit target is desired at the 500 sales target’? Show the amount for fixed and for variable costs.

c. Discuss the advantages of using a target costing model versus using cost-based pricing. LO.1