28PGB
Question
Green Thumb operates a commercial plant nursery, where it propagates plants for garden centers throughout the region. Green Thumb has \(5,300,000 in assets. Its yearly fixed costs are \)625,000, and the variable costs for the potting soil, container, label, seedling, and labor for each gallon-size plant total \(1.70. Green Thumb’s volume is currently 490,000 units. Competitors offer the same plants, at the same quality, to garden centers for \)4.00 each. Garden centers then mark them up to sell to the public for \(9 to \)12, depending on the type of plant.
Requirements
1. Green Thumb’s owners want to earn an 10% return on the company’s assets. What is Green Thumb’s target full product cost?
2. Given Green Thumb’s current costs, will its owners be able to achieve their target profit?
3. Assume Green Thumb has identified ways to cut its variable costs to \(1.55 per unit. What is its new target fixed cost? Will this decrease in variable costs allow the company to achieve its target profit?
4. Green Thumb started an aggressive advertising campaign strategy to differentiate its plants from those grown by other nurseries. Green Thumb does not expect volume to be affected, but it hopes to gain more control over pricing. If Green Thumb has to spend \)135,000 this year to advertise and its variable costs continue to be $1.55 per unit, what will its cost-plus price be? Do you think Green Thumb will be able to sell its plants to garden centers at the cost-plus price? Why or why not?
Step-by-Step Solution
VerifiedThe target full cost for the company is $1,430,000.
As the name suggests, variable cost refers to the cost that varies with the level of production. In other terms, the variable cost has a direct relation with the production level; if the production level decreases, the variable cost also decreases and vice versa.
Particulars | Amounts ($) |
Revenue at market price (490000*4) | 1,960,000 |
Less: Desired profit (5300000*10%) | (530,000) |
Target full cost | $1,430,000 |
Particulars | Amounts ($) |
Revenue (490000*4) | 1,960,000 |
Less: Variable cost (490000*1.70) | 833,000 |
Contribution margin | 1,127,000 |
Less: Fixed costs | (625,000) |
Operating income (A) | $502,000 |
Target profit (B) [5,300,000*10%] | $530,000 |
Difference (A-B) | $(28,000) |
Comment:
As per the above analysis, the owners will not be able to achieve their target profit because the actual profit of the company is less than its target profit.
Particulars | Amounts ($) |
Fixed cost | 625,000 |
Add: Variable cost (490000*1.55) | 759,500 |
Total cost | $1,384,500 |
Comment:
As the new cost of $1,384,500 is less than the target cost of $1,430,000, it will allow the company to achieve its target profit.
Particulars | Amounts ($) |
Fixed costs | 625,000 |
Advertising costs | 135,000 |
Variable costs (490000*1.55) | 759,500 |
Total costs | 1,519,500 |
Add: Desired profit (5300000*10%) | 530,000 |
Sales value | 2,049,500 |
Divide: Number of units | 490,000 |
Cost-plus price | $4.182 |
Comment:
As per the above analysis, the company may sell its plants at higher prices than usual market rates because by adding the advertising costs, the company has control over the pricing.