Question 3: Target costing

Fry Ltd are developing a new type of umbrella for cyclists. Market research has indicated that customers would be willing to pay 80 for the product. The company usually expect a profit margin of 12% on products.

Fixed costs for enhancements to production machinery are expected to be 250,000 per year. The company currently has orders for 8000 units this year. Materials are expected to cost 25 per unit. Each product requires 45 minutes of specialist labour to manufacture.

The personnel department are having difficulty in recruiting these specialist staff and report that the expected rate of pay is 20- 25 per hour.

Required:

a) Calculate the maximum hourly rate that Fry Ltd could pay to achieve the Target Cost.

(5 marks)

b) A reduction in the fixed costs of 45,000 could be achieved but this would result in increased labour time to 1 hour per unit. Explain whether Fry Ltd should consider doing this?

(5 marks)

c) Alternatively, cheaper materials costing only 22 could be used but this would also result in each unit taking 1 hour to make. Should Fry consider this? Give reasons for your answer.

(5 marks)

d) Alternatively, each member of specialist staff could be provided with an apprentice to assist them. The apprentice will cost 8 per hour and this would enable the specialist staff to spend only half an hour on each unit of the product. Should Fry consider this?

(5 marks)

e) Suggest other possible actions that Fry could take to enable them to pay the expected rate of pay per hour.

(5 marks)