Robert's Medical Equipment Company manufactures hospital beds. Its' most popular model, Deluxe, sells for $5,000. It has variable costs of $2,800 and fixed costs of $1,000 per unit, base on an average production run of 5,000 units. It normally has four production runs a year, with $400,000 in setup costs each time. Plant capacity can handle up to six runs a year for a total of 30,000 beds.
A competitor is introducing a new hospital bed similar to Deluxe that will sell for $4,000.
Management believes it must lower the price to compete. Marketing believes that the new price will
increase sales by 25% a year. The plant manager thinks that production can increase by 25% with the
same level of fixed costs. The company currently sells all the Deluxe beds it can produce.
Required:
a. What is the annual operating income from Deluxe at the current price of $5,000 and normal production?
b. What is the annual operating income from Deluxe if the price is reduced to $4,000 and sales in units increase by 25%?
c. What is the target cost per unit for the new price if target operating income is 20% of sales?
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