2. Drew Mellow builds custom homes in Miami. Mellow was approached not too long

Question

2. Drew Mellow builds custom homes in Miami. Mellow was approached not too long ago by a client about a potential project, and he submitted a bid of S590,000, derived as follows Land Construction materials Subcontractor labor costs $90,000 20,000 50,000 S360,000 72,000 40,000 Construction overhead: 20% of direct costs Allocated c Total cost rate overhead 72 Mellow adds a 25% profit margin to all jobs, computed on the basis of total cost. In this client's case the profit margin amounted to $118,000 ($472,000 x 25%), producing a bid price of $590.000. Assume that 60% of construction overhead is fixed. Required: A. Suppose that business is presently very slow, and the client countered with an offer on this home of $455,000. Should Mellow accept the client's offer? Why? Consider all relevant costs related to this transaction only B. IfMellow has more business than he can handle, how much should he be willing to accept for the home? Why?

Explanation / Answer

Solution A:

As business is slow, still Mellow got offer higher than its relevant cost, therefore accepting client offer will result in incremental income of $66,200, therefore mellow should accept the client offer.

Solution B:

As Mellow have more business than it can handle, it means business is not slow and Mellow can sell all of its inventory at regular price. Therefore Mellow willing to accept not less than $590,000 its regular bid price.

Computation of income on accepting client offer - Mellow Particulars Amount Revenue $455,000.00 Relevant cost: Land $90,000.00 Construction material $120,000.00 Sub contractor labor cost $150,000.00 Variable construction overhead $28,800.00 Income on accepting client offer $66,200.00

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