QUESTION Proven Ltd manufactures specialpurpose computers ac

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

Solution

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