QUESTION Proven Ltd manufactures special-purpose computers according to customer
ID: 2605372 • Letter: Q
Question
QUESTION Proven Ltd manufactures special-purpose computers according to customer specifications. The company operated at 70% of practical capacity in 2017 with the following results: Sales Less sales connussions ( 10%) Net sales 12.500 1.250 11.250 Expenses Direct material Direct labour Manufacturing overhead Manufacturing overhead Corporate administration Total costs Profit before tax Profit tax (40%) Net profit 3,000 3.750 1.125 750 variable fixed fixed 9.000 2.250 900 1.350 The variable overhead was 30% of direct labor. Proven Ltd expects continued operations at 70% of capacity. In January 2018. Proven Ltd submitted a bid of S82.500.000 on a special-purpose computer for Kowloon Bank. Proven Ltd used a pricing formula in deriving the bid amount which was based on 2017's operating results. The company can still operate under full capacity with the acceptance of new order Estimated direct material Estimated direct labour Estimated manufacturing overhead at 50% of direct labor Estimated corporate overhead at 10% of direct labor Estimated total costs excluding sales commissions Add 25% for profit and taxes Suggested price (with profit) before sales commission Suggested total price ($74.250 90%) to adjust for commission S'000 14.600 28,000 14.000 2.800 59.400 14.850 74.250 82.500 P.1
Explanation / Answer
Answer
At 70% Capacity
Order Bid
Sales
12500
82500
(Less) Commission
1250
8250
Net Sales
11250
74250
Expenses
Direct material
3000
14600
Direct Labor
3750
28000
manufacturing Overhead-variable
1125
8400
Manufacturing Overhead – fixed (considering that estimated amount relate to additional fixed overhead requirement)
750
14000
Corporate administration – fixed (considering that estimated amount relate to additional fixed overhead requirement)
375
2800
Total Cost
9000
67800
Profit before Tax
2250
6450
Profit Tax (40%)
900
2580
Net Profit after tax
1350
3870
Hence, if the offer is accepted, the Net Profit after tax will increase by $3870000.
Then, Proven should not accept the COUNTER OFFER. This is because any Offer is only to be accepted if its giving additional benefits. This means that Bid price should atleast cover the VARIABLE COSTs to be incurred for production of that ORDER.
In this case, Variable cost adds up to $51000000 (DM 14600 + DL 28000 + Variable manufacturing overhead (30% of 28000=)8400 = 14600 +28000 + 8400 = 51000) which is more than the counter offered bid price of $50000000
Hence, counter offer not to be accepted.
Break Even should be that level of Bid price where the additional offer neither gives Net Income/Net Loss. For that it is assumed that Fixed Cost will not increase. Solving the following equation will give us a Break Even Bid price
A
Direct material
14600
B
Direct Labor
28000
C
manufacturing Overhead-variable
8400
D
Commission 10%
0.1x
E=A+B+C+D
Bid price
x
Hence, 14600+28000+8400+0.1x = x
51000 = x – 0.1x
51000 = 0.9x
x=56666 approx.
Hence, the Bid price should be approx 56666666.
Verifying the above---
Sales
56667
(Less) Commission
5667
Net Sales
51000
Expenses
Direct material
14600
Direct Labor
28000
manufacturing Overhead-variable
8400
manufacturing Overhead - fixed
0
Corporate administration - fixed
0
Total Cost
51000
Profit before Tax
0 [Hence, at Break Even]
Profit Tax (40%)
0
Net Profit
0
At 70% Capacity
Order Bid
Sales
12500
82500
(Less) Commission
1250
8250
Net Sales
11250
74250
Expenses
Direct material
3000
14600
Direct Labor
3750
28000
manufacturing Overhead-variable
1125
8400
Manufacturing Overhead – fixed (considering that estimated amount relate to additional fixed overhead requirement)
750
14000
Corporate administration – fixed (considering that estimated amount relate to additional fixed overhead requirement)
375
2800
Total Cost
9000
67800
Profit before Tax
2250
6450
Profit Tax (40%)
900
2580
Net Profit after tax
1350
3870