Video ranging between 9:10 to 9:20 completely confused me. First we discussed that the profit is $25 then we did some other calculation and drive the profit of $10. Why we did this… not able to understand completely.

There are 2 techniques to determine profit. 1) From gross selling price 2) From cost

At 9:10 he is explaining the 2) scenario, so we want cost + 25%. Then he is showing us what percentage to use to calculate (25/125 is 1/5 which is 20%), because if we suppose that the cost is 100 (this is not in the task, it is just an assumption) than required profit is 25, so selling price is 125. Therefore we can use the 25/125 logic to our example where the selling price is 50, so as we go back from the selling price to reach the cost we do: 20% * 50 = 10 profit, so cost is 50-10=40.

In the 2nd example , When we are working out the target cost, do we go with the assumption that the work to make the product goes on for a number of years as we have not factored in the cost of Building and Equipment into the workings ?

$5,000,000 / 40,000 units is a building and equipment cost of $125 .. If production does not therefore last more than 1 year , this product therefore wouldn’t be cost efficient ?

Or are we working on the assumption that the business has the building and equipment for other production already?

Because the question says that the sales are 40,000 units per year, we are effectively assuming that they last indefinitely (as we always do with ROI just as in Paper MA).

Even if they were not lasting indefinitely it would be wrong to say that it would not be cost efficient on your workings because if it only lasted for one year there would be sale proceeds from the building and equipment at the end of the year.

I don’t know which example you are referring to. However on your figures, if they want a mark-up of 25% on cost and if the selling price is $50, then the target cost is $40 (not $10. $10 is the profit they want to make).

Please sir I NEED TO KNOW HOW TO SOLVE THIS QUESTION the selling price of product ZIGMA is set to be $250 for each unit and sales for the coming year are expected to be 500 units if the company requires a return of 15%in the coming year on its investment of $250000in product ZIGMA the target cost for the coming year is how do i proceed with this question the choices are 145 155 165 175

Targeted revenue is 500 x $250 = $125000 The required ROI 15% from $ 250000 is $37500 Targeted cost is $125000-$37500 = $87500 Targeted cost per unit = $87500/500 units = $175

Why would we divide 50 by 150? The $50 is the realistic selling price. This is equal to cost + profit. We are told the profit we want is based on the cost. So we take the cost x as 100% and the profit as 25% this will give you the selling price at 125% x. We know this is $50 dollars so to get x we divide by 125/100 You could also have this as an equation. 1x + .25x = 50 1.25x = 50 x = 50/1.25 x=40

Thank you John. Based on your presentation target costing is effectively the same as conventional cost plus pricing. Why the target cost is always calculated on a per unit basis according to your explanation?

kamran.khan says

Dear Mike,

Video ranging between 9:10 to 9:20 completely confused me. First we discussed that the profit is $25 then we did some other calculation and drive the profit of $10. Why we did this… not able to understand completely.

rajcika1995 says

There are 2 techniques to determine profit.

1) From gross selling price

2) From cost

At 9:10 he is explaining the 2) scenario, so we want cost + 25%. Then he is showing us what percentage to use to calculate (25/125 is 1/5 which is 20%), because if we suppose that the cost is 100 (this is not in the task, it is just an assumption) than required profit is 25, so selling price is 125. Therefore we can use the 25/125 logic to our example where the selling price is 50, so as we go back from the selling price to reach the cost we do: 20% * 50 = 10 profit, so cost is 50-10=40.

hope this clarifies.

John Moffat says

rajcika1995 is quite correct.

(But who is Mike? Nobody called Mike has ever had anything at all to do with our Paper PM lectures 🙂 )

SwissCheese says

His name be John, not mike. Soon Sir John Moffat if my petition reaches 100k signatures. So far we are on 3 signatures

MichaelManshoven says

In the 2nd example , When we are working out the target cost, do we go with the assumption that the work to make the product goes on for a number of years as we have not factored in the cost of Building and Equipment into the workings ?

$5,000,000 / 40,000 units is a building and equipment cost of $125 .. If production does not therefore last more than 1 year , this product therefore wouldn’t be cost efficient ?

Or are we working on the assumption that the business has the building and equipment for other production already?

John Moffat says

Because the question says that the sales are 40,000 units per year, we are effectively assuming that they last indefinitely (as we always do with ROI just as in Paper MA).

Even if they were not lasting indefinitely it would be wrong to say that it would not be cost efficient on your workings because if it only lasted for one year there would be sale proceeds from the building and equipment at the end of the year.

acca324 says

in example 2, what is the assumption that the 30% of 5M is the profit objective when the problem did not say so?

John Moffat says

But the question does say so!! It says that a return on investment of 30% is required.

binidire says

Thank you.

John Moffat says

You are welcome 🙂

SusanKurian says

therefore for every 100 of cost the Selling price is 125, i.e, 100/125*50=$40

and therefore target cost is $50-$40 = $10

is that correct?

John Moffat says

I don’t know which example you are referring to. However on your figures, if they want a mark-up of 25% on cost and if the selling price is $50, then the target cost is $40 (not $10. $10 is the profit they want to make).

chocolatestarfish says

Please sir I NEED TO KNOW HOW TO SOLVE THIS QUESTION

the selling price of product ZIGMA is set to be $250 for each unit and sales for the coming year are expected to be 500 units if the company requires a return of 15%in the coming year on its investment of $250000in product ZIGMA the target cost for the coming year is

how do i proceed with this question

the choices are

145

155

165

175

victorgoh says

Targeted revenue is 500 x $250 = $125000

The required ROI 15% from $ 250000 is $37500

Targeted cost is $125000-$37500 = $87500

Targeted cost per unit = $87500/500 units

= $175

Kungfuash says

Hi John,

In Target Costing, you gave example of calculating TC when profit was 25% of/on Cost and you calculated by 25/125*50= $10.

Why here we are calculating by 100/150*10.5 = $7 ?

Why not same as 50/150 * 10.50 = $3.5 TC ?

Thanks

agu3ro says

You can also say,

TC= (125/100 )x = 50

TC= (100/125)50 = 40

adch111 says

Why would we divide 50 by 150?

The $50 is the realistic selling price. This is equal to cost + profit.

We are told the profit we want is based on the cost.

So we take the cost x as 100% and the profit as 25% this will give you the selling price at 125% x.

We know this is $50 dollars so to get x we divide by 125/100

You could also have this as an equation.

1x + .25x = 50

1.25x = 50

x = 50/1.25

x=40

Ebtehal says

It’s very helpful, thank you.

John Moffat says

You are welcome 🙂

nhelal89 says

thank you

John Moffat says

You are welcome 🙂

phantomghostly says

whts is the easiest way to understand maxmin, Maximin. and Minimax

John Moffat says

I do not understand why you have posted this as a comment on a lecture on target costing!!

Maximin etc. are all explained in my free lectures on risk and uncertainty.

John Moffat says

No, no – it is nothing like cost plus pricing!!

With cost plus pricing we start with the cost and add on a % to get the selling price. But there is then no incentive to reduce costs.

With target costing we start with a realistic selling price and then decide what the maximum cost has to be to be able to get the desired profit.

alie2018 says

Thank you John. Based on your presentation target costing is effectively the same as conventional cost plus pricing. Why the target cost is always calculated on a per unit basis according to your explanation?