The management of Kizer Corporation would like to set the selling price on a new product using the absorption costing approach to cost-plus pricing.The company's accounting department has supplied the following estimates for the new product: Management plans to produce and sell 8, 000 units of the new product annually.The new product would require an investment of $1, 580, 000 and has a required return on investment of 10%. The markup percentage on absorption cost is closest to:
A)25%
B)10%
C)15%
D)41%

Question

The management of Kizer Corporation would like to set the selling price on a new product using the absorption costing approach to cost-plus pricing.The company's accounting department has supplied the following estimates for the new product:  Management plans to produce and sell 8, 000 units of the new product annually.The new product would require an investment of $1, 580, 000 and has a required return on investment of 10%. The markup percentage on absorption cost is closest to:
A)25% 
B)10% 
C)15% 
D)41%

Quizplus · Accepted Answer

The required return on investment is 10%, which means the company needs to earn $158,000 ($1,580,000 x 0.10) in profit annually. 
Using the absorption costing approach, the total cost per unit is: 
Direct materials + Direct labor + Variable overhead + Fixed overhead
= $80 + $20 + $18 + ($1,257,000 ÷ 8,000 units)
= $80 + $20 + $18 + $157.13
= $275.13

Adding a markup percentage on absorption cost to cover profit, we get:
Selling price = Absorption cost + (Markup percentage × Absorption cost)
$275.13 + (Markup percentage × $275.13) = $433.13

Solving for the markup percentage:
Markup percentage = (Selling price - Absorption cost) ÷ Absorption cost
= ($433.13 - $275.13) ÷ $275.13
= 0.57 or 57%

Therefore, the closest markup percentage on absorption cost to cover the required return on investment is 41% (choice D).

The Management of Kizer Corporation Would Like to Set the Selling