Question

Venus plc (Venus) manufactures fibre optic cables. This is an increasingly competitive market and the Chief Financial Officer (CFO) of Venus has suggested that the company's pricing policy should change. Specifically, he has suggested that Venus' quotation for a new contract should be based on target costing. The costs relevant to this are listed below and the prices in this market are all quoted on a per metre basis: Target price $196 per metre of cable. The contract is estimated at 25,000 metres of cable. Venus profit margin 18%. Material cost $50 per metre. Production of each metre takes 0.5 hours of labour at a cost of $30 per hour. Each metre of cable will use 1.2 units of machine time at a cost of $43 per hour. Delivery and installation will cost $12 per metre of cable. Total design costs for all 25,000 metres of cable are expected to be $900,000. The rate of failed metres of cable is expected to amount to 3%. These metres will be reworked at an average cost of $35 per metre. Required: a) Calculate the target cost for the new contract and the cost gap. (10 marks) b) Comment on actions that Venus might take to reduce the cost gap. (5 marks) c) Explain how undertaking a Total Quality Management (TQM) approach may help Venus in its adoption of target costing. (5 marks) TOTAL 20 MARKS

Answer 1

Solution as per below image:

Requirement (a): Calculation for Target cost and cost gap of New Contract Target Cost = Target Selling Price - Profit % x Target Selling Price = 196 - ( 18% X 196) Target cost = $ 160.72 Total Target Cost of New Contract = $ 160.72 X 25000 = $ 4018000 Calculation For Estimated Cost of New Contract Particulars Material Cost $ 50 X 25000) Labour Cost (0.50 hours X $ 30 per hour X 25000) Machine Cost( 1.20 units X 43 X 25000) Delivery and Installation cost ($ 12 X 25000) Design Cost Cost of Rework ( 25000 X 3% X $ 35) Estimated Cost of Contract Amount in $ 1250000 375000 1290000 300000 900000 26250 4141250 Target Cost Gap = Estimated Cost - Target Cost = 4141250 - 4018000 Target Cost Gap = $123250 Requirement (b): Venus can take following actions to reduce the Cost Gap: 1) Venus should try to reduce failure rate to zero so that rework cost could be savec 2) Venus should Acquire new and more efficient manufacturing technique which will reduce machine time 3) Venus should search alternative sources of material suppliers who can supply materials at cheapest cost without compromising quality 4) Training of staff in more efficient technique would increase their efficiency which help to reduce labour costs. 5) Focus on cutting non value added activities which can reduce manufacturing cost Requirement (C): 1)Total quality management (TQM) is the continual process of detecting and reducing or eliminating errors in manufacturing, streamlining supply chain management, improving the customer experience, and ensuring that employees are up to speed with training. 2) The focus of the process is to improve the quality of an organization's outputs, including goods and services through continual improvement of internal practices. 3) Total Quality Management approach can help companies to leverage their ability to monitor and control their cost to generate a profit. 4) TQM approach by focussing on improving quality at every stage of manufacturing process, help organisation to reduce costs