The following conversation took place between Juanita Jackson, Vice President of Marketing, and Les Miles, Controller of Diamond Computer Company:

Juanita: I am really excited about our new computer coming out. I think it will be a real market success.

Les: I’m really glad you think so. I know that our success will be determined by our price. If our price is too high, our competitors will be the ones with the market success.

Juanita: Don’t worry about it. We’ll just mark our product cost up by 25%, and it will all work out. I know we’ll make money at those markups. By the way, what does the estimated product cost look like?

Les: Well, there’s the rub. The product cost looks as if it’s going to come in at around $1,200. With a 25% markup, that will give us a selling price of $1,500. 

Juanita: I see your concern. That’s a little high. Our research indicates that computer prices are dropping and that this type of computer should be selling for around $1,250 when we release it to the market.

Les: I’m not sure what to do.

Juanita: Let me see if I can help. How much of the $1,200 is fixed cost?

Les: About $200.

Juanita: There you go. The fixed cost is sunk. We don’t need to consider it in our pricing decision. If we reduce the product cost by $200, the new price with a 25% markup would be right at $1,250. Boy, I was really worried for a minute there. I knew something wasn’t right.

Write a brief memo from Les Miles to Juanita Jackson 

(a) Responding to her solution to the pricing problem, and 

(b) Explaining how target costing could be used to solve the problem.