You are considering setting up a software development business. To set up the enterprise you will need to buy equipment costing $100,000. This equipment will be depreciated straight line over 5 years to a zero salvage value. Its market value at the end of the 5 years will be zero. You will need to rent space at $5,000 per year for the five years of the project. You will also need to hire 5 software engineers at $50,000 each, per year to work in this project. Marketing and selling costs will be $100,000 per year during the project. Materials costs are $20 per unit. You expect to sell 6,000 units of the product each year for the five years. If your tax rate is 40%, and you require a return of 12%, what is the minimum price you should charge per unit of the product?
To calculate the minimum price you should charge per unit of the product, we need to consider the various costs and calculate the total cost per unit.
1. Equipment Cost:
The equipment cost is $100,000, and it will be depreciated straight-line over 5 years to a zero salvage value. Therefore, the annual depreciation expense for the equipment is $100,000 / 5 = $20,000.
2. Rental Expense:
The space rental expense is $5,000 per year for the five years. So, the annual rental expense is $5,000.
3. Employee Salaries:
You need to hire 5 software engineers at a salary of $50,000 each per year. Therefore, the total annual employee salary expense is 5 * $50,000 = $250,000.
4. Marketing and Selling Costs:
The marketing and selling costs are $100,000 per year during the project.
5. Materials Cost:
The materials cost is given as $20 per unit, and you expect to sell 6,000 units of the product each year for five years. So, the total annual materials cost is $20 * 6,000 = $120,000.
Now, let's calculate the total annual cost:
Total annual cost = Depreciation expense + Rental expense + Employee salaries + Marketing and selling costs + Materials cost
= $20,000 + $5,000 + $250,000 + $100,000 + $120,000
= $495,000
To determine the minimum price you should charge per unit, we need to calculate the break-even quantity. The break-even quantity is the quantity at which the revenue generated equals the total cost incurred.
Break-even quantity = Total annual cost / Number of units sold
= $495,000 / 6,000
= $82.50
Hence, the minimum price you should charge per unit of the product is $82.50 to cover all the costs and achieve a 12% return.