NEW HAMPSHIRE CORP.

uses target costing and life-cycle costing to aid in the final decision to release new products to production. A new product is currently being evaluated. Market research has surveyed the potential market for the product and believes that its unique features will generate a total demand over the products life of 70,000 units at an average price of $360. The target costing team has members from market research, design, accounting, and production engineering departments. The team has worked closely with key customers and suppliers. A value analysis of the product has determined that the total cost for the various value-chain functions using the existing technology are as follows: (Assume all are present values).

VALUE-CHAIN FUNCTION					TOTAL COST OVER PRODUCT LIFE
Research and development							$2,300,000
Product design							750,000
Manufacturing (70% outsourced to suppliers)							8,000,000
Marketing							1,800,000
Distribution							2,200,000
Customer service							950,000
Total cost over product life							$16,000,000

Management has a target contribution to profit percentage of 40% of sales. This contribution provides sufficient funds to cover corporate support costs, taxes, and a reasonable profit.

In addition to the existing scenario above (scenario #1), consider two additional scenarios where certain of the costs above could be reduced:

Scenario #2

Approximately 70% of the manufacturing costs for this product consist of materials and parts that are purchased from suppliers. Key suppliers on the target-costing team have suggested process improvements that will reduce supplier cost by 20%. Customer service costs and are expected to rise by $300,000 over the life of the product.

Scenario #3

New process technology can be purchased at a cost of $220,000 that will reduce non-outsourced manufacturing costs by 25%.

REQUIRED:

1. Prepare a product-life-cycle income statement for all three of the scenarios shown above.

2. For each scenario, decide whether the new product should be released to production. WHY?

3. For each scenario, compute the percent of each item in the value chain to the total cost. Comment on what this information indicates.

4. ASSUME that Alternative #2 was selected. Using a target costing approach, BY HOW MUCH would manufacturing costs need to be further reduced in order to meet the firms profit objective?

5. How could traditional income statements lead to incorrect decisions about whether to move forward with the product?