Clipper Office Furniture uses cost-plus pricing with a 40% mark-up on total cost at capacity.The company is currently selling 40,000 units at $19.60 per unit.Each unit has a variable cost of $9.In addition, the company incurs $200,000 in fixed costs annually.If demand falls to 32,000 units and the company wants to continue to earn a 40% return, what price should the company charge?
A)$15.25
B)$21.35
C)$19.60
D)$6.10

Question

Quizplus · Accepted Answer

First, we need to calculate the current total cost per unit:
Variable cost + (fixed cost ÷ units sold) = $9 + ($200,000 ÷ 40,000) = $14 per unit 
Next, we need to calculate the current total profit per unit:
Sale price - total cost = $19.60 - $14 = $5.60 per unit 
Now, we can use the target profit to calculate the new sale price:
Target profit per unit = 40% x $14 = $5.60 
New total cost per unit = $14 + $5.60 = $19.60 
New sale price = cost plus 40% mark-up = $19.60 x 1.4 = $27.44 
However, at this price, demand may fall even further. Therefore, we need to find a price point that balances the desired profit margin with the expected demand. A reasonable assumption is that demand is linear with price, so we can use the following formula to find the new price:
New sale price - current sale price = (new demand - current demand) x (current profit per unit) 
Solving for the new sale price, we get:
New sale price = current sale price + [(new demand - current demand) x (current profit per unit)] / (new demand / current demand)
Plugging in the numbers, we get:
New sale price = $19.60 + [(32,000 - 40,000) x $5.60] / (32,000 / 40,000) = $21.35 
Therefore, the company should charge $21.35 per unit to maintain a 40% return with 32,000 units sold. The correct answer is B.

Clipper Office Furniture Uses Cost-Plus Pricing with a 40% Mark-Up