Omaha Synthetic Fibers Inc. specializes in the manufacture of synthetic fibers that the company uses in many products such as blankets, coats, and uniforms for police and firefighters. The company has been in business for 20 years and has been profitable each of the past 15 years. Omaha Synthetic Fibers uses a standard-costing system and applies overhead on the basis of direct-labor hours. Management has recently received a request to bid on the manufacture of 800,000 blankets scheduled for delivery to several military bases. The bid must be stated at full cost per unit plus a return on full cost of no more than 15 percent before income taxes. Full cost has been defined as including all variable costs of manufacturing the product, a reasonable amount of fixed overhead, and reasonable incremental administrative costs associated with the manufacture and sale of the product. The contractor has indicated that bids in excess of $25 per blanket are not likely to be considered.
In order to prepare the bid for the 800,000 blankets, Andrea Lightner, director of cost management, has gathered the following information about the costs associated with the production of the blankets.
Direct material .................................................................................. $1.50 per pound of fibers
Direct labor ........................................................................................................ $7.00 per hour
Direct machine costs* .................................................................................. $10.00 per blanket
Variable overhead ........................................................................... $3.00 per direct-labor hour
Fixed overhead ................................................................................ $8.00 per direct-labor hour
Incremental administrative costs ....................................................... $2,500 per 1,000 blankets
Special fee† ....................................................................................................... $.50 per blanket
Material usage ........................................................................................... 6 pounds per blanket
Production rate .......................................................................... 4 blankets per direct-labor hour
*Direct machine costs consist of items such as special lubricants, replacement of needles used in stitching, and maintenance costs. These costs are not included in the normal overhead rates.
†Omaha Synthetic Fibers recently developed a new blanket fiber at a cost of $750,000. In an effort to recover this cost, management has instituted a policy of adding a $.50 fee to the cost of each blanket using the new fiber. To date, the company has recovered $125,000. Lightner knows that this fee does not fit within the definition of full cost as it is not a cost of manufacturing the product.
Required:
1. Calculate the minimum price per blanket that Omaha Synthetic Fibers Inc. could bid without reducing the company's net income.
2. Using the full cost criteria and the maximum allowable return specified, calculate Omaha Synthetic Fibers Inc.'s bid price per blanket.
3. Independent of your answer to requirement (2), assume that the price per blanket that Omaha Synthetic Fibers Inc. calculated using the cost-plus criteria specified is greater than the maximum bid of $25 per blanket allowed. Discuss the factors that management should consider before deciding whether to submit a bid at the maximum acceptable price of $25 per blanket?