Question

You have been approached by a potential client who could bring you considerable business. She says, "I'd like to find an alternative vendor for my future orders of 5,000/yr., but their pricing must be competitive." Your CFO has supplied you with the following information. Current product standard costs are as follows: Selling price per unit: $5,000 $1,400/unit direct material $400/unit direct labor $200/unit variable overhead $200/unit fixed overhead (this figure is the result of the budgeted fixed overhead of $2,000,000 and budgeted sales volume of 10,000 units) Income Tax rate = 40% The board of directors has requested a thorough presentation to determine whether taking on this potential customer is a good idea. Assume that your factory is fully operational and that you will not have any learning curve impacts.

In your presentation, answer the following questions from the board using the data from the CFO:

1. What is the lowest possible price you could offer to this potential customer (you know that you have sufficient capacity without working overtime and without adding any new equipment to make this order)? Please show your calculations.
2. In terms of capacity, under what conditions would offering this lowest possible price be a bad decision? Why?
3. Create a pro-forma income statement to show a net income/net loss for the year.
4. You have been considering investing in automation to eliminate some factory labor if you get this large order. This technology advancement will cost an added $100,000/yr. to lease (net of taxes), but it will reduce labor cost/unit on the customer's units by 50%. How would this change the lowest possible price you could offer to this potential customer and at least still break even? Please show your calculations.

Answer 1

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