Janes Jones, the sales representative for Perfect Designs, works entirely on commission. Neil Gross, the cost accountant for the company, prepares the bid based on the following cost information:
| Direct Costs | ||
| Design Costs | $20,000 | |
| Materials | $70,000 | |
| Direct Labor | $10,000 | |
| Fittings | $20,000 | |
| Overhead Costs | ||
| Design Software | $5,200 | |
| Materials Handling | $4,800 | |
| General and Admin | $8,000 | |
| Total Overhead | $18,000 | |
| Full Product Costs | $138,000 |
Based on Perfect Designs policy of pricing at 120% of full cost, Neil Gross determines that the bid for this job should be $165,600. However, Janet Jones is very alarmed and tells Neil Gross that at that price, the company will likely not win the bid. She explains that she spent $600 of company funds to take the fashion models to a day spa where they revealed that a bid of $156,000 would win the job. Janet further reasons that the company will still make money if it wins the bid at $156,000 because it is higher than the full cost of $138,000.
Please assist with the following question:
2. Neil Gross suggests that if Janet Jones is willing to use cheaper materials, she can achieve a bid of $156,000. What is the target cost of materials that will allow Janet Jones to submit a bid of $156,000 assuming a target markup of 20% of full cost? Note: A cost reduction can only be achieved from materials, no other costs can be reduced.
To determine the target cost of materials that will allow Janet Jones to submit a bid of $156,000 while maintaining a target markup of 20% of full cost, we need to first calculate the desired profit margin and then work backward to find the allowable materials cost.
Here’s the step-by-step calculation:
Full Cost Calculation: Full Cost = Direct Costs + Overhead Costs Full Cost = $138,000 (Given)
Target Markup Calculation: Target Markup = 20% of Full Cost Target Markup = 0.20 * $138,000 = $27,600
Desired Profit Margin: Desired Profit Margin = Bid Price – Full Cost Desired Profit Margin = $156,000 (Desired Bid Price) – $138,000 (Full Cost) Desired Profit Margin = $18,000
Now, we know that the desired profit margin is $18,000. Janet wants to maintain this profit margin while reducing the bid price to $156,000 by cutting down on materials costs.
Let M represent the target cost of materials that will allow Janet to submit a bid of $156,000. The equation for the bid price can be expressed as follows:
Bid Price = Direct Costs (excluding materials) + M + Overhead Costs + Desired Profit Margin
We already have the values for Direct Costs (excluding materials) and Overhead Costs:
Direct Costs (excluding materials) = $20,000 (Design Costs) + $10,000 (Direct Labor) + $20,000 (Fittings) = $50,000
Overhead Costs = $18,000 (Given)
Now, let’s plug these values into the equation:
$156,000 = $50,000 + M + $18,000 + $18,000
Now, we can solve for M:
M = $156,000 – $50,000 – $18,000 – $18,000 M = $70,000
So, to achieve a bid of $156,000 while maintaining a target markup of 20% of full cost, Janet Jones would need to target a cost of materials (M) equal to $70,000.
In summary, by reducing the materials cost to $70,000 and keeping other costs constant, Janet can submit a bid of $156,000 while still achieving a 20% profit margin based on the full cost of $138,000, as suggested by Neil Gross.
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