Madison Electric Pump Corporation manufactures electric pumps for commercial use. The company produces three models, designated as regular, advanced, and deluxe. The company uses a job-order cost accounting system with manufacturing overhead applied on the basis of direct-labor hours. The system has been in place with little change for 25 years. Product costs and annual sales data are as follows:

For the past 10 years, the company’s pricing formula has been to set each product’s target price at 110 percent of its full product cost. Recently, however, the regular-model pump has come under increasing price pressure from offshore competitors. The result was that the price on the regular model has been lowered to $220.
The company president recently asked the controller, “Why can’t we compete with these other companies? They’re selling pumps just like our regular model for $212. That’s only two bucks more than our production cost. Are we really that inefficient? What gives?” The controller responded by saying, “I think this is due to an outmoded product-costing system. As you may remember, I raised a red flag about our system when I came on board last year. But the decision was to keep our current system in place. In my judgment, our product-costing system is distorting our product costs. Let me run a few numbers to demonstrate what I mean.”
Getting the president’s go-ahead, the controller compiled the basic data needed to implement an activity-based costing system. These data are displayed in the following table. The percentages are the proportion of each cost driver consumed by each product line.

Required:
1. Compute the target prices for the three pump models, based on the traditional, volume-based product-costing system.
2. Compute new product costs for the three products, based on the new data collected by the controller. Round to the nearest cent.
3. Calculate a new target price for the three products, based on the activity-based costing system. Compare the new target price with the current actual selling price for the regular model pump.
4. Write a memo to the company president explaining what has been happening as a result of the firm’s traditional volume-based product-costing system.
5. What strategic options does management have? What do you recommend, andwhy?

Regular Ml Advanced Model Deluxe Model Annual sales (units.. Product costs: 1,000 0,000 Direct materi Direct labor . Manufacturing overhead $ 20 S 84 20 (1 hr. at $20) 4012 hr. at $20) 40 (2 hr. at $20) 170 (1 hr. at $170) 340 (2 hr. at $170) 3402hr at $170) $210 Total product cost S464 The calculation of the predetermined overhead rate is as follows: $2,960,000 240,000 600,000 700,000 500,000 750,000 800,000 590,000 $7,140,000 Depreciation, machinery Depreciation, taxes, and insurance for factory Engineering Purchasing, receiving and shipping Inspection and repair of defects Material handling Miscellaneous manufacturing overhead costs Direct-labor budget: Regular model: Advanced model: Deluxe model: 20,000 hours 2,000 hourS 20,000 hours 42,000 hours overhead $7140,000 s170 per hour Predetermined overhead rate: Budgeted direct-labor hours 42,000 hours Product Lines Cost Driver Regular Advanced Deluxe Model 13% Activity Cost Pool Model 39% Model 48% : Depreciation, machinery Machine time Maintenance, machineny 47% 6% 47% Inspection and repair of defects ll: Purchasing, receiving, and shipping Number of material orders 47% 8% 45% Material handling Depreciation, taxes, and insurance for factory Miscel aneous manufacturing overhead V: Factory space usage 42% 15% 43%