Julian Pharma manufactures hospital beds. Its most popular model, Deluxe, sells for $5,000. It has variable costs totaling $2,650 and fixed costs of $1,200 per unit, based on an average production run of 5,000 units. It normally has four production runs a year, with $400,000 in setup costs each time. Plant capacity can handle up to six runs a year for a total of 30,000 beds.
A competitor is introducing a new hospital bed similar to Deluxe that will sell for $3,800. Management believes it must lower the price to compete. The marketing department believes that the new price will increase sales by 25% a year. The plant manager thinks that production can increase by 25% with the same level of fixed costs. The company currently sells all the Deluxe beds it can produce.
Required: | a. | What is the annual operating income from Deluxe at the current price of $5,000? |
| b. | What is the annual operating income from Deluxe if the price is reduced to $3,800 and sales in |
units increase by 25%?
| c. | What is the target cost per unit for the new price if target operating income is 30% of sales? |
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