Blog · Finance metrics and formulas · Finance and FP&A teams
Target return pricing adds the required profit per expected unit to unit cost. Calculate the price from invested capital, annual costs, and sales volume, then test how lower volume changes the result.
How to calculate desired ROI per unit: multiply invested capital by the required return rate and divide by expected unit sales for the same period. That produces the required profit in dollars per unit; add full cost per unit to calculate the target return price.
Required period profit = Invested capital × Target return rate
Required profit per unit = Required period profit / Expected units sold
Target price per unit = Full cost per unit + Required profit per unit
The return rate is a percentage of capital, while the per-unit return allowance is a dollar amount. The distinction matters: adding a target return percentage directly to unit cost creates a markup calculation rather than a return-on-capital calculation.
OpenStax's pricing-policy chapter describes the target return objective as pricing to generate a specific profit within a stated period. It also identifies the central limitation: the calculation depends on estimated unit sales. A mathematically sufficient price may be commercially unrealistic if buyers will not accept it.
Define the capital base before applying the formula. It might include the equipment and working capital assigned to the product line, using an average or another approved balance. Keep that definition and the target return basis consistent. The example below uses a supplied average invested-capital balance and an annual pretax operating-profit target, before financing costs.
Bring a unit cost schedule, a fixed-cost budget, an invested-capital schedule, and a sales-volume forecast. Keep the period, product, unit of measure, currency, and scenario on each schedule. Cases, individual items, and shipped units cannot share one denominator unless the conversion is explicit.
| Workbook field | What belongs in it |
|---|---|
| Invested capital | The agreed capital base assigned to the product line |
| Target return rate | Required profit divided by that capital base for the stated period |
| Variable cost per unit | Costs that vary with the unit sold |
| Fixed operating costs | Relevant period costs that do not vary within the assumed range |
| Expected net units sold | Units expected to generate sales after the defined return treatment |
| Net selling price | Revenue per unit after discounts, rebates, and other agreed deductions |
Use cost per net unit when reconciling the sales denominator. For the cost behavior, OpenStax's contribution-margin discussion distinguishes variable costs from fixed costs within a relevant activity range. A volume scenario that requires another factory shift may also require a different fixed-cost assumption.
A fictional Wisconsin supplier is pricing a product line for the year ending December 31, 2026. Finance supplies these assumptions. Fixed operating costs include the period's relevant depreciation; the equipment investment itself is not also charged as an annual operating expense.
| Input | Value (USD where applicable) | Basis |
|---|---|---|
| Average invested capital (USD) | 500,000 | Supplied capital schedule |
| Annual target return | 20.0% | Supplied management assumption |
| Expected units sold | 20,000 | Annual net sales-volume forecast |
| Variable cost per unit (USD) | 22.00 | Supplied unit cost schedule |
| Annual fixed operating costs (USD) | 160,000 | Supplied operating budget |
First calculate full cost at the expected volume, then add the required profit allowance.
| Step | Calculation | Result (USD) |
|---|---|---|
| Variable costs for the year | 20,000 × 22.00 | 440,000 |
| Total operating costs | 440,000 + 160,000 | 600,000 |
| Full cost per unit | 600,000 / 20,000 | 30.00 |
| Required annual profit | 500,000 × 20.0% | 100,000 |
| Required profit per unit | 100,000 / 20,000 | 5.00 |
| Target price per unit | 30.00 + 5.00 | 35.00 |
The required return allowance is $5.00 per unit. It is not 20% of the $30.00 unit cost. The capital requirement, the target rate, and the expected sales volume together determine that allowance.
The same formula can be written directly from variable and fixed costs:
Target price = Variable cost per unit + (Fixed operating costs + Required profit) / Expected units
Here that is $22.00 + ($160,000 + $100,000) / 20,000 = $35.00. This version makes the separate recovery of fixed costs and target profit visible.
The price is only useful if multiplying it back through the projected sales schedule returns the required profit.
| Check | Calculation | Amount (USD) |
|---|---|---|
| Net revenue | 20,000 × 35.00 | 700,000 |
| Variable costs | 20,000 × 22.00 | 440,000 |
| Contribution | 700,000 − 440,000 | 260,000 |
| Fixed operating costs | From the operating budget | 160,000 |
| Operating profit | 260,000 − 160,000 | 100,000 |
Operating profit divided by invested capital is $100,000 / $500,000 = 20.0%, which matches the target. Revenue less full operating costs also gives $700,000 − $600,000 = $100,000. Both checks must agree.
The operating profit margin is different: $100,000 / $700,000 = 14.3%. Capital is the denominator for the target return, while sales is the denominator for this margin. It is not a gross-margin target because the example's cost base includes all relevant operating costs. The contribution margin ratio guide explains the intermediate contribution measure.
Keep invested capital, variable cost per unit, fixed costs, and the target rate unchanged. Change only annual units. Required annual profit remains $100,000 because the assumed capital base and target rate have not changed.
| Annual units | Variable costs (USD) | Full operating costs (USD) | Full cost per unit (USD) | Required profit per unit (USD) | Target price (USD) |
|---|---|---|---|---|---|
| 16,000 | 352,000 | 512,000 | 32.00 | 6.25 | 38.25 |
| 20,000 | 440,000 | 600,000 | 30.00 | 5.00 | 35.00 |
| 25,000 | 550,000 | 710,000 | 28.40 | 4.00 | 32.40 |
At 16,000 units, $38.25 produces $612,000 of revenue. Subtracting $512,000 of full operating costs leaves the same $100,000 target profit. At 25,000 units, $32.40 produces $810,000 of revenue against $710,000 of costs, again leaving $100,000. All per-unit figures are shown to cents; these scenario values require no intermediate rounding.
The risk appears if volume falls without a price change. Selling 16,000 units at the original $35.00 generates $560,000 of revenue. After $512,000 of costs, profit is $48,000 and the return is $48,000 / $500,000 = 9.6%. A higher required price in a lower-volume scenario does not establish that customers will pay it.
Finance owns the cost and capital definitions; the commercial team owns the demand assumptions and evidence for achievable net price. Review those inputs together. For a broader view of the customer's economics, see unit economics; for the meaning of an investment return outside this pricing calculation, see return on investment.
Bring your cost schedule, capital balance, expected units, and target return assumptions to Covirage. Covirage maps the columns, its tools compute and check the price-and-volume figures, and the external AI model explains the results with every figure traced to its rows. Create a free Covirage account and bring a sample of your own file; creating the account takes about a minute.
See customer profitability for the commercial reporting context.
The target return rate is a percentage of invested capital. The required return allocated to each unit is a dollar amount. Keeping those units distinct prevents adding a percentage directly to a dollar cost when setting the selling price.
No. It calculates a price using assumed sales volume, costs, and invested capital. Actual profit changes if customers buy fewer units, discounts reduce realized price, or costs increase. Test demand and compare actual results with the assumptions before treating the target as achievable.
Yes, if the target profit is intended to remain after those fixed operating costs. Divide the relevant period's fixed costs by expected units and add variable cost per unit. Do not add the same fixed cost again in the return allowance.
Both start from costs, but a standard cost-plus calculation applies a chosen markup to cost. Target return pricing derives the profit allowance from invested capital and a required return over a stated period, then allocates that allowance across expected unit sales.