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Theo Co is a business which grows through diversification and is currently considering expansion into manufacturing clothing which will be sold to companies who will sell the items under their own brand name. The first two clothing products Theo Co will manufacture are dresses and skirts.
Theo Co normally uses a pricing policy of a 10% mark-up on standard prime cost on its products. However, as the clothing market is highly competitive, the finance director is considering using a target costing approach but wants to retain the same mark-up.
Dresses
The maximum price the market will support is $22 per unit. 60% of the direct cost of each dress is expected to be cotton.
Skirts
40% of the direct cost of each skirt is expected to be wool. The minimum price Theo Co can source the wool necessary to make one skirt is currently $4.36 which has been built into the budget. On this basis, Theo Co has determined that the cost gap between the budgeted cost per skirt and the target cost per skirt is $0.45.
Theo Co will also set up a small service department to deal with the support functions for this new venture.
Assuming that target costing principles are adopted, what is the maximum selling price that Theo Co can charge per skirt? (to two decimal places)
Answer given by Kaplan: $11.50
Budgeted cost $10.90 and cost gap ($0.45)
Hence target cost should be $10.45.
Add mark-up of 10% $1.05 => SP is $11.50.I don’t know how to calculate the budgeted cost. Could you please advice?
The wool costs $4.36. This is 40% of the full cost, and so the full cost is 4.36/40% = $10.90.
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