Boat Builders build custom-made pleasure boats that range in price from $90,000 to $750,000. For the past 30 years, Boat Builders has determined the selling price of each boat by estimating the cost of direct materials, direct manufacturing labor, and allocated portion of total overhead (which includes nonmanufacturing cost), and adding a 20% markup to the total of this cost. For example, a recent price quotation was determined as follows:

Direct materials $30,000
Direct manufacturing labor 48,000
Total overhead 12,000
The total estimated cost of 90,000
Markup 20% * $90,000 18,000
Selling price 108,000

The total overhead figure is determined by budgeting total overhead costs for the year and allocating them at 25% of direct manufacturing labor costs.
If a customer rejects the price and business is slack, Boat Builders often reduces the markup to as little as 5% of total estimate cost. The average markup for the year is expected to be 15%.
Boat Builders just completed a course on pricing in which contribution margin was emphasized. The feel this approach will help in determining the selling prices of this company's boats.
Total overhead for the year has been budgeted as $1,800,000 of which $1,080,000 is fixed and the remainder varied in proportion to direct manufacturing labor costs.
A. Assume the customer in the example rejects the $108,000 quotation and also rejects a $94,500 quotation (5% markup) during a slack period. The customer counters with a $90,000 offer. Compute the minimum selling price Boat Builders could quote without decreasing or increasing operating income?
B. What is the main disadvantage of emphasizing contribution margin in pricing decisions?

Answer rating: 100% (QA)

Pricing using CM methodology only takes into account variable costs hence the impo... View the full answer