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“A company has a target mark up of 25% and sells to a competitive market where market price is $120 per unit. Company’s current costs per unit are $46 for variable costs and $60 for fixed costs, and it has budgeted output of 10,000 units.
What is the minimum production required to close the target cost gap?”The solution for this is showing that we should calculate required production based on fixed cost:
– Target cost = $120/125% = $96
$46 of this is variable, $50 is fixed.
=> Required production = ($60*10,000)/$50 = 12,000 units.Could you please help me explain why do we base on fixed cost ($50) rather than the total unit cost ($96)?
How do we know when we should do it this way and when we should use full unit cost?Thank you,
The variable cost per unit will stay at $46 however many they produce.
The total fixed cost will stay at the budgeted amount of $60,000 however many they produce, by definition. However the fixed cost per unit will change depending on the level of production.
To achieve a target cost of $96, the fixed cost will have to be $50 per unit. Given that the total fixed cost must stay at $60,000, then in order to achieve an absorption rate of $50 per unit they will have to produce 12,000 units.
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