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DirectCall Company uses the total cost concept of applying the cost-plus approach to product pricing. The costs of producing and selling 4,000 units of mobile phones are as follows: \(\begin{array}{lcc}\text { Variable costs: } & \text { Fixed costs: } \\\ \text { Direct materials } & \$ 140.00 \text { per unit } & \text { Factory overhead } \\ \text { Direct labor } & 40.00 & \text { Selling and ad } . \\\ \text { Factory overhead } & 25.00 & \\ \text { Selling and adm. exp. } & 15.00 \\ \text { Total } & \$ \$ 220.00 & \end{array}\) DirectCall Company desires a profit equal to a \(25 \%\) rate of return on invested assets of \(\$ 400,000\). a. Determine the amount of desired profit from the production and sale of mobile phones. b. Determine the total costs and the cost amount per unit for the production and sale of 4,000 units of mobile phones. c. Determine the markup percentage (rounded to two decimals) for mobile phones. d. Determine the selling price of mobile phones. Round to the nearest dollar.

Step by step solution

01

Calculate Desired Profit

The desired profit is calculated by applying the rate of return to the invested assets. Given a 25% rate and $400,000 in invested assets, the desired profit is computed as follows:\[ \text{Desired Profit} = 0.25 \times 400,000 = 100,000 \]

02

Calculate Total Variable Costs

To find the total variable costs, multiply the total variable cost per unit by the number of units. Each unit has a variable cost of $220.00, so for 4,000 units:\[ \text{Total Variable Costs} = 4,000 \times 220 = 880,000 \]

03

Calculate Total Fixed Costs

Add the fixed costs for factory overhead and selling and administrative expenses. Given values are $150,000 for factory overhead and selling and administrative expenses:\[ \text{Total Fixed Costs} = 150,000 \]

04

Calculate Total Costs

The total cost is the sum of total variable costs and total fixed costs:\[ \text{Total Costs} = \text{Total Variable Costs} + \text{Total Fixed Costs} = 880,000 + 150,000 = 1,030,000 \]

05

Calculate Cost Per Unit

Divide the total costs by the number of units to find the cost per unit:\[ \text{Cost Per Unit} = \frac{1,030,000}{4,000} = 257.50 \]

06

Calculate Total Desired Sales Revenue

Total desired sales revenue is the sum of the total costs and the desired profit:\[ \text{Total Desired Sales Revenue} = \text{Total Costs} + \text{Desired Profit} = 1,030,000 + 100,000 = 1,130,000 \]

07

Calculate Selling Price Per Unit

To find the selling price per unit, divide the total desired sales revenue by the number of units:\[ \text{Selling Price Per Unit} = \frac{1,130,000}{4,000} = 282.50 \]

08

Calculate Markup Percentage

Calculate the markup percentage using the selling price and cost per unit:\[ \text{Markup Percentage} = \left( \frac{\text{Selling Price Per Unit} - \text{Cost Per Unit}}{\text{Cost Per Unit}} \right) \times 100 = \left( \frac{282.50 - 257.50}{257.50} \right) \times 100 = 9.71\% \]

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Total Cost Concept

The total cost concept is a fundamental notion in cost-plus pricing. This approach calculates the total cost of producing and selling a product, then adds a desired profit margin to set the selling price. To compute the total cost, businesses need to sum both variable and fixed costs. By knowing the total costs, companies ensure that they cover all expenses and profit when pricing products. In the DirectCall Company example, the total costs involve both variable and fixed costs, amounting to $1,030,000 for producing 4,000 units. This comprehensive approach provides a clear picture of the financial requirements for making and selling a product. It ensures businesses don't undersell their products or incur losses.

Markup Percentage

Markup percentage is a critical part of cost-plus pricing. It refers to the percentage added over the cost of a product to arrive at the selling price. It essentially represents the profit margin desired by the business. The formula for computing the markup percentage is:

• Subtract the cost per unit from the selling price per unit.
• Divide the difference by the cost per unit.
• Multiply the result by 100 to convert it to a percentage.

For the DirectCall Company, the markup percentage is 9.71%. This represents the additional cost added on top of the production cost to achieve the desired profit. It is a crucial component in pricing strategies for ensuring competitiveness and profitability.

Variable and Fixed Costs

In cost-plus pricing, understanding variable and fixed costs is essential. Variable costs change with the level of production, like direct materials, labor, and factory overhead. For DirectCall Company, these were the costs directly tied to producing one mobile unit. Conversely, fixed costs remain constant regardless of output, like factory overhead and selling expenses, tallying $150,000 for the exercise.

• Variable Costs: Totaled per unit, providing flexibility in pricing depending on production scale.
• Fixed Costs: Leveraged over higher production volumes to lower the cost per unit, critical in pricing strategies.

Understanding these costs helps companies decide how many items to produce and at what price, ensuring that they cover costs and generate a profit.

Profit Maximization

Profit maximization in cost-plus pricing focuses on setting a price that ensures the greatest possible profit. By starting with total costs, businesses add a markup to cover desired returns. The goal is to balance sales volume with price to achieve the highest possible profit. For DirectCall Company, the desired profit is $100,000, calculated with a 25% rate of return on $400,000 of invested assets. This approach requires:

• Accurate calculation of production and operational costs.
• Strategic choice of markup percentages to remain competitive while achieving desired profits.

It ensures that pricing isn't set too high, potentially decreasing sales, nor too low, risking profitability. This balance is key for sustainable business growth and financial health.