TARGET PRICES, TARGET COSTS, VALUE ENGINEERING. Avery, Inc. manufactures two component parts for the television industry:

• Tvez: Annual production and sales of 50,000 units at a selling price of $48.72 per unit.
• Premia: Annual production and sales of 25,000 units at a selling price of $72 per unit.

Avery includes all R&D and design costs in engineering costs. Assume that Avery has no marketing, distribution, or customer-service costs.

The direct and overhead costs incurred by Avery on Tvez and Premia are described as follows:

	Tvez	Premia		Total
Direct materials costs (variable)	$1,020,000	$720,000		$1,740,000
Direct manufacturing labour costs (variable)	360,000	240,000		600,000
Direct machining costs (fixed)	180,000	120,000		300,000
Manufacturing overhead costs:
Machine setup costs			112,500
Testing costs			600,000
Engineering costs			480,000
Manufacturing overhead costs				1,192,500
Total costs				$3,832,500

Averys management identifies the following activity cost pools, cost drivers for each activity, and the costs per unit of cost driver for each overhead cost pool:

Activity	Description	Cost Driver	Cost per Unit of Cost Driver
Setup	Preparing machine to manufacture a new batch of products	Setup-hours	$30 per setup-hour
Testing	Testing components and final product (each unit is tested individually)	Testing-hours	$2.40 per testing- hour
Engineering	Designing products and processes and ensuring their smooth functioning	Complexity of product and process	Costs assigned to products by special study

Over a long-run time horizon, Averys management views direct materials costs and direct manufacturing labour costs as variable with respect to the units of Tvez and Premia produced. Direct machining costs for each product do not vary over this time horizon and are fixed long-run costs. Overhead costs vary with respect to their chosen cost drivers. For example, setup costs vary with the number of setup-hours. Additional information is as follows:

	Tvez	Premia
Production batch size	500 units	200 units
Setup time per batch	15 hours	18 hours
Testing and inspection time per unit of product produced	2.5 hours	5 hours
Engineering costs incurred on each product	$200,000	$280,000

Avery is facing competitive pressure to reduce the price of Tvez and has set a target price of $48, well below its current price of $52.50. The challenge for Avery is to reduce the cost of Tvez. Averys engineers have proposed a new product design and process improvements for the New Tvez to replace Tvez. The new design would improve product quality, and reduce scrap and waste. The reduction in prices will not enable Avery to increase its current sales. (However, if Avery does not reduce prices, it will lose sales.)

The expected effects of the new design relative to Tvez are as follows:

3. Direct materials costs for New Tvez are expected to decrease by $2.50 per unit.
4. Direct manufacturing labour costs for New Tvez are expected to decrease by $0.70 per unit.
5. Time required for testing each unit of New Tvez is expected to be reduced by 0.5 hours.
6. Machining time required to make New Tvez is expected to decrease by 20 minutes. It currently takes 1 hour to manufacture 1 unit of Tvez. The machines are dedicated to the production of New Tvez.
7. New Tvez will take 7 setup-hours for each setup.
8. Engineering costs are unchanged.

Assume that the batch sizes are the same for New Tvez as for Tvez. If Avery requires additional resources to implement the new design, it can acquire these additional resources in the quantities needed. Further assume the costs per unit of cost driver for the New Tvez are the same as those described for Tvez.

Instructions

Form groups of two students to complete the following requirements.

Required

1. Develop full product costs per unit for Tvez and Premia, using an activity-based product costing approach.
2. What is the markup on the full product cost per unit for Tvez?
3. What is Averys target cost per unit for New Tvez if it is to maintain the same markup percentage on the full product cost per unit as it had for Tvez?
4. Will the New Tvez design achieve the cost reduction targets that Avery has set?
5. What price would Avery charge for New Tvez if it used the same markup percentage on the full product cost per unit for New Tvez as it did for Tvez?
6. What price should Avery charge for New Tvez, and what next steps should Avery take regarding New Tvez?