Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 8

Target Cost; Warehousing McFee Supply, a wholesaler, has determined that its operations have three primary activities: purchasing, warehousing, and distributing. The firm reports the following operating data for the year just completed:

Activity	Cost Driver	Quantity of Cost Driver	Cost per Unit of Cost Driver
Purchasing	Number of purchasing orders	1,000	$150 per order
Warehousing	Number of moves	8,000	30 per move
Distributing	Number of shipments	500	80 per shipment

McFee buys 100,000 units at an average unit cost of $10 and sells them at an average unit price of $20. The firm also has a fixed operating cost of $250,000 for the year.

McFee’s customers are demanding a 10 percent discount for the coming year. The company expects to sell the same amount if the demand for price reduction can be met. McFee’s suppliers, however, are willing to give only a 2 percent discount.

Required McFee has estimated that it can reduce the number of purchasing orders to 700 and can decrease the cost of each shipment $5 with minor changes in its operations. Any further cost saving must come from reengineering the warehousing processes. What is the maximum cost (i.e., target cost) for warehousing if the firm desires to earn the same amount of profit next year?

Step 1 of 5

Target costing

Target costing is used to determine target costs using current price and desired profit. Target cost is calculated by deducting desired profit from selling price to determine the maximum costs which company can incurred. Target costs help to determine the costs per unit which company should incur to earn the desired profit and selling price.