Discussion Forum #$3$ TIF $25-3$: Setting a Product Price

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.