Memphis Electrical makes small electric motors for a variety of home appliances. Memphis sells the motors to appliance makers, who assemble and sell the appliances to retail outlets.
Although Memphis makes dozens of different motors, it does not currently make one to be used in garage-door openers. The company’s market research department has discovered a market for such a motor.
The market research department has indicated that a motor for garage-door openers would likely sell for $26. A similar motor currently being produced has the following manufacturing costs:
Direct materials . $13.00
Direct labor ..... 6.00
Overhead ..... 8.00
Total ...... $27.00
Memphis desires a gross margin of 20% of the manufacturing cost.
1. Suppose Memphis used cost-plus pricing, setting the price 20% above the manufacturing cost. What price would be charged for the motor? Would you produce such a motor if you were a manager at Memphis? Explain.
2. Suppose Memphis uses target costing. What price would the company charge for a garage-door-opener motor? What is the highest acceptable manufacturing cost for which Memphis would be willing to produce the motor?
3. As a user of target costing, what steps would Memphis managers take to try to make production of this product feasible?