Binder Manufacturing produces small electric motors used by appliance manufactur
ID: 2421035 • Letter: B
Question
Binder Manufacturing produces small electric motors used by appliance manufacturers. In the past year, the company has experienced severe excess capacity due to competition from a foreign company that has entered Binder's market. The company is currently bidding on a potential order from Dacon Appliances for 6,000 Model 350 motors. The estimated cost of each motor is $40, as follows:
Direct material $25
Direct labor 5
Overhead 15
Total $45
The predetermined overhead rate is $3 per direct labor dollar. This was estimated by dividing estimated annual overhead ($15,000,000) by estimated annual direct labor ($5,000,000). The $15,000,000 of overhead is composed of $6,000,000 of variable costs and $9,000,000 of fixed costs. The largest fixed cost relates to depreciation of plant and equipment.
Required
a. With respect to overhead, what is the opportunity cost of producing a Model 350 motor?
b. Suppose Binder can win the Dacon business by bidding a price of $39 per motor (but no higher price will result in a winning bid). Should Binder bid $39?
c. Discuss how an allocation of overhead based on opportunity cost would facilitate an appropriate bidding decision.
Explanation / Answer
Part – 1 Opportunity Cost
For calculating opportunity cost the relevant cost is all variable cost including variable overheads and fixed overheads are not considered since they do not vary in the short term with changes in activity.
Total Opportunity Cost per 350 model motor has follows
Particulars
Amount ($)
Direct Material
25
Direct Labour
5
Variable Overheads
6
Total Opportunity Cost / Variable cost
36
Part – b & C
If binder win Dacon business by bidding price of $ 39 per motor,
Total Bidding Price
39
Less
Total Variable Cost
36
Profit Margin
3
In the present scenario Binder has experienced that excess capacity
And for bidding decisions relevant cost would be variable cost
In this situation Binder will get profit margin of $ 3 per motor since total variable cost is $ 36.
Decision: Binder can bid the price of $ 39 per motor.
Particulars
Amount ($)
Direct Material
25
Direct Labour
5
Variable Overheads
6
Total Opportunity Cost / Variable cost
36
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