Avocado Ltd produces small electronic components for kitchen appliances. This year it expects to produce 10 000 units of component X. The variable manufacturing cost of component X is $2 per unit and the variable selling and administrative cost of component X is $3 per unit. In addition, to produce component X Avocado Ltd incurs annual fixed manufacturing cost of $50 000 and annual fixed selling and administrative cost of $60 000. If the target profit is $2 per unit, and using cost plus pricing approach, the mark up percentage based on total variable costs is:

A) 260%.
B) 80%.
C) 63.6%.
D) 12.5%.

Question

Karla Vasquez · Accepted Answer

Final Answer : A, Explanation :  The total variable cost per unit is $2 (manufacturing) + $3 (selling and administrative) = $5. The target profit per unit is $2. Therefore, the total cost per unit is $5 (variable cost) + $2 (target profit) = $7. The markup percentage based on total variable costs is calculated as (Target Profit / Total Variable Cost) * 100 = ($2 / $5) * 100 = 40%. However, to find the price per unit, we add the target profit to the total variable cost, which gives us $7. The markup percentage based on total variable costs to achieve this price is actually calculated as [(Price - Total Variable Cost) / Total Variable Cost] * 100. Given the mistake in the initial calculation, the correct approach to find the markup percentage is to consider the total costs including fixed costs, which are not directly provided in the calculation for markup percentage based on total variable costs. The correct answer involves calculating the price that includes the target profit and then determining the markup over the variable costs. Given the options and the mistake in the initial calculation, the correct markup percentage to achieve the target profit over the total variable costs is not directly calculable from the provided information without considering the fixed costs, which are not relevant to the markup calculation based on variable costs alone. Therefore, the correct answer should reflect the necessary markup to achieve a price that covers both the variable costs and the target profit, but the provided calculation method was incorrect. The correct markup percentage is actually determined by the formula [(Selling Price - Variable Cost) / Variable Cost] * 100. Without the selling price, we incorrectly applied the formula for markup based on variable costs. The correct answer, considering the need for a markup that covers variable costs plus the target profit, would require knowing the intended selling price, which involves adding the target profit margin on top of the total costs (variable + fixed), and then calculating the markup percentage from there. Given the error in calculation and explanation, the correct choice should be reconsidered based on the correct approach to calculating markup percentage based on total variable costs plus the target profit margin, which was not accurately represented in the initial explanation.

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