Tiffany Cosmetics manufactures, and sells a variety of makeup and beauty products. The company has come up with its own patented formula for a new anti-aging cream The company president wants to make sure the product is priced competitively because its purchase will also likely increase sales of other products. The company anticipates that it will sell 400,000 units of the product in the first year with the following estimated costs:
Product design and licensing ............ $ 1,000,000
Direct materials ............... 1,800,000
Direct manufacturing labor ........... 1,200,000
Variable manufacturing overhead ......... 600,000
Fixed manufacturing overhead .......... 2,000,000
Fixed marketing ............... 3,000,000

Required
1. The company believes that it can successfully sell the product for $ 38 a bottle. The company’s target operating income is 40% of revenue. Calculate the target full cost of producing the 400,000 units. Does the cost estimate meet the company’s requirements? Is value engineering needed?
2. A component of the direct materials cost requires the nectar of a specific plant in South America. If the company could eliminate this special ingredient, the materials cost would drop by 45%. However, this would require design changes of $ 300,000 to engineer a chemical equivalent of the ingredient. Will this design change allow the product to meet its target cost?
3. The company president does not believe that the formula should be altered for fear it will tarnish the company’s brand. She prefers that the company spend more on marketing and increase the price. The company’s accountants believe that if marketing costs are increase by $ 400,000 then the company can achieve a selling price of $ 42 per bottle without losing any sales. At this price, will the company achieve its target operating income of 40% of revenue?
4. What are the advantages and disadvantages of pursuing alternative 2 and alternative 3 above?