Case 3: Dragon Development. Dragon Development is in the business of building si

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Case 3: Dragon Development. Dragon Development is in the business of building single family homes. It is currently in the process of developing a tract in which it will offer 20 single family homes. With the decline in the real estate market, the company has been losing profitability. It wants to regain its profitability by adopting target costing to manage profits and costs. The following initial specifications have been worked out for the new tract of homes that will be the pilot for the target-cost system: Table 1 Proposed Construction Specifications— New Tract Foundation/Roof Area (sq. ft.) 2,800 Heated Floor Space (sq. ft.) 3,600 Garage (sq. ft.) 600 Deck 500 Patios/Walkways/Lawn 5,500 Number of Bathrooms 5 The intended buyers for these homes are professional upper-middle class families (e.g., lawyers, doctors, accountants, managers, small entrepreneurs, etc.) in which both spouses typically work. The quality specifications are designed to meet the expectations of this class of buyers.

Target Profit & Prices. It is customary for developers to aim for a 20 percent contribution margin from each house. Recent market surveys indicate that a house with the proposed quality and design specifications will sell for around $399,000. Typically, marketing and sales commissions costs average 4 percent of the selling price. Therefore, if the proposed house sells for $399,000, the net price to the developer will be $383,000 (rounded off). Also, the desired profit contribution will be $80,000 (rounded off). The $399,000 price represents a drop in prices due to the recent decline in real estate values. When the concept for these homes was originally developed, this type of home sold in the $450,000 range. The Company has come to the conclusion that to earn the 20 percent desired profit margin with the lower price of $399,000, it must have a good system for planning and managing costs.

Cost History/Estimates. The initial cost estimates suggest that the total development cost will be much higher than the price the market is willing to pay. Besides construction cost, the new homes are expected to have land cost of $70,000 per home and construction financing of 8 percent per annum with a typical construction period of 9 months. These estimates are based on using, as a starting cost estimate, the cost of a recent housing tract with similar quality homes. Table 2 below provides the specifications for a typical home (123 Main Street) in this recently completed tract. Table 2 Construction Specifications— 123 Main Street (Two-Story Home) Foundation/Roof Area (sq. ft.) 1,800 Heated Floor Space (sq. ft.) 2,935 Garage (sq. ft.) 490 Deck 500 Patios/Walkways/Lawn 5,300 Number of Bathrooms 3

While 123 Main Street is smaller than the proposed tract, its quality is similar. The costs of building 123 Main Street are detailed in Table 3. Customer/Competition Analysis. To make trade-offs intelligently, the Company has commissioned a market survey that shows the relative values customers place on different “hard” and “soft” functionalities in a home. The survey also ranked competitor offerings on these same functionalities. This data was arrayed in a “Quality Function Deployment” (QFD) matrix so all relevant data could be related to the design parameters. The QFD matrix is shown in Table 4. Value Engineering. To make design changes the company formed a team consisting of the architect, interior designer, structural engineer, and framer to develop some value-engineering ideas for cost redesign. The team met and came up with a set of ideas to guide them through the specific changes they wanted to consider. These ideas are summarized in Table 5. Required: a. What is the overall “target cost” for the new housing tract? What is the construction cost target? b. Prepare an initial cost estimate for the proposed home using 123 Main Street as a cost model. (Hint: You may want to group costs by common drivers and then use these drivers to predict the new tract’s costs.) What is the gap between the target cost and your initial cost estimate? c. Develop a cost-reduction strategy for the company that considers the lifetime ownership costs to the customer and will allow Dragon to meet the target cost for the new tract (including land and financing). Use the customer preferences shown in Table 4 and the value engineering ideas in Table 5 as a guide. However, if you need to make additional assumptions state them in your analysis. d. Write a brief paragraph on each major cost-reduction strategy you have adopted. Briefly explain the quality and functionality tradeoffs you have used to meet the target cost and defend these trade-offs.

Table 3 Construction Costs—123 Main Street Item Cost Architectural Fees $ 7,500 Interior & Landscape Design 1,500 Building Permits 5,253 Construction Insurance 235 Temporary Facilities 750 Water Meter & Utility Trench 488 Excavation 750 Concrete Forms 1,500 Concrete for foundation and floors 8,500 Roof Covering 4,750 Garage Door & Opener 650 Site Cleanup 500 Lumber Rough for framing 17,500 Lumber Finish for doors/window trims and molding 8,944 Framing Labor 22,225 Carpentry Finish installing cabinets, trims, etc. 6,375 Doors & Frames 3,453 Windows & Sashes 6,413 Stucco Exterior 8,025 Sheet Rock (gypsum board for interior walls) 8,763 Rough Electrical Wiring 5,013 Rough Plumbing 7,975 Telephone Wiring 413 Cost of Framing Changes & Bonus for on-time finish 1,405 Bathroom and Kitchen Cabinets 7,856 Hardware for framing 900 Hardware Finish (door knobs, hinges, etc.) 1,719 Plumbing Finish 2,519 Electrical Finish (wall switches, plates, etc.) 4,954 Light Fixtures 3,591 Heating/Ventilation (equipment plus labor) 6,125 Built-in Window Planter Boxes 1,044 Insulation 4,825 Finish Flooring (carpeting and tile) 13,343 Built-in Kitchen Appliances 5,616 Spiral Stairway—Metal 2,319 Mirrors, Towel Holders, etc. 1,250 Fireplace 1,690 Blinds and Shutters for windows 3,381 Painting & Wall Paper 7,925 Garage Cabinets 438 Tile Work (materials and labor) 6,181 Fencing 725 Concrete Driveway and Walkways 5,129 Plants & Lawn 4,606 Sprinkler System 956 Total Cost $215,972

Explanation / Answer

the expected selling price of each house (unit) is about $339,000 and the expected total cost per each unit to complete the construction is $215,972

now the total profit for each unit will be= 339,000- 215,972= $123,026

hence, the profit is much higher, it is adviced that to proceed with construction of houses and sell them in market

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