Keller Technology produces specialised machinery customised to their clients' need. Barings Systems had ordered a custom machine

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Question:

Keller Technology produces specialised machinery customised to their clients' need. Barings Systems had ordered a custom machine five months ago and paid a 5% deposit on the $275,000 machine. The cost of producing the machine for Barings are as follows:

Direct materials $63,400

Direct labour $57,600

Manufacturing overhead applied:

Variable $28,800

Fixed $14,400

Fixed selling and administrative costs $16,420

Total $180,620

Just as Keller completed producing the machine, Barings went into receivership. As Barings was unable to pay for the machine, the deposit paid to Keller was forfeited. Keller is now considering the options available to them, with regards to the machine that Barings had ordered. The production manager has identified three options for Keller.

Option A: Pegasus Engineering is willing to buy the Barings' machine if it can be reworked to Pegasus' specifications. The re-worked machine will be sold to Pegasus as a special order for $231,900. The additional identifiable costs to re-work the machine to Pegasus' requirements are as follows:

Direct materials $19,400

Direct labour $13,200

Total $32,600

Option B: It is possible to convert the Barings machine into a standard machine that Keller can normally sell for $199,375. However, as this is a conversion of a custom machine, a 4% discount will be offered to attract a buyer. In order to complete the conversion, Keller will need to incur the following costs:

Direct materials $7,880

Direct labour $9,400

Total $17,280

Option C: Keller will sell the machine in its current completed state for $185,000.

The following information is available regarding Keller's operations:

The allocation rates for the manufacturing overhead and fixed selling and administrative costs are:

Manufacturing costs:

Variable 50% of direct-labour costs

Fixed 25% of direct-labour costs

Fixed selling and administrative costs 10% of the total of directmaterial, direct-labour, and manufacturing overhead costs.

The sales commission rate on sales is 3 percent.

REQUIRED:

a. Determine the dollar contribution each of the three alternatives and choose which option is best (financially) for Keller. Show all workings.

b. If Pegasus makes Keller a counteroffer, what is the lowest price Keller should accept for the reworked machinery from Pegasus? Explain your answer?