Question

1. E. Berg & Sons build custom-made pleasure boats that range in price from $30,000 to $250,000. For the past 30 years, Ed Berg Sr., has determined the selling price of each boat by estimating the cost of direct materials, direct manufacturing labor, an allocated portion of total overhead (which includes nonmanufacturing cost), and adding a 20% markup to the total of this cost. For example, a recent price quotation was determined as follows: Direct materials $10,000 Direct manufacturing labor 16,000 Total overhead 4.000 Total estimated cost 30,000 Markup, 20% $30,000 6.000 Selling price $36.000 The total overhead figure is determined by budgeting total overhead costs for the year and allocating them at 25% of direct manufacturing labor costs. If a customer rejects the price and business is slack, Ed Berg Sr., often reduces his markup to as little as 5% of total estimated cost. The average markup for the year is expected to be 15%. Ed Berg Jr., just completed a course on pricing in which contribution margin was empha- sized. He feels this approach will help in determining the selling prices of his company's boats. Total overhead for the year has been budgeted at $600,000 of which $360,000 is fixed and the remainder varies in proportion to direct manufacturing labor costs. a. Assume the customer in the example rejects the $36,000 quotation and also rejects a $31.500 quotation (5% markup) during a slack period. The customer counters with a $30,000 offer. Compute the minimum selling price Ed Berg Jr., could quote without decreasing or increasing operating income? b. What is the main disadvantage of emphasizing contribution margin in pricing decisions?

Answer 1

The total overhead (Budgeted) is $ 600000/-

                                                            Existing                                                                            New

Fixed Cost                                         $ 3,60,000                                                                       $ 360000

Direct Manufacturing Labor    $ 180000 (25% of total estimated cost) $ 180000

Total variable Cost $ 60000                                                                            $ 60000

                                                            ----------

Total estimated cost                       $ 600000 $ 600000

Mark up 20%                                    $ 120000                            Mark up 15 % $ 90000

                                                            -----------                                                                          ---------

Selling price                                      $ 720000 /- $ 690000

                                                            ========                                                                        =======

1. The minimum selling price is $ 690000/-without decreasing or increasing operation income. Here we have considered the reduction the mark up to 5 % as mentioned and we have considered at 15 %.
2. The main disadvantage of emphasizing contribution margin in pricing decisions are as under 1.costing principle contribution is equal to sales minus variable cost. Based on the contribution we make the decision but here the costs are linear and can be cleanly divided into fixed and variable components hence no decision can be taken

      2. multi-product companies are assumed to keep the mix between products constant even as the sale price changes.

      3. Lastly, if we assume that manufacturers sell and produce exactly the same number of units. The extent that these assumptions affect the usefulness of the technique varies from company to company. However, small-business owners should consider these shortcomings when interpreting results. For example, if a large portion of the business is discounted sales to large customers, this technique may not be other units.