Douglas Company has been asked to submit a bid on supplying gas masks to the Pen

Question

Douglas Company has been asked to submit a bid on supplying gas masks to the Pentagon. The company's current cost structure per mask is as follows.

a. Assume that there would be no variable sales commission on this special order. Determine the lowest unit price that Douglas can bid without reducing its current level of operating income.

b. Assume the company desires a 36 percent contribution margin ratio from this sale and that a special sales commission of 4 percent of the bid price will be applied to the order instead of its normal $6 variable sales commission. Determine the bid price per unit given these unique circumstances.

Direct materials $ 9 Direct labor 8 Variable manufacturing overhead 7 Variable sales commissions 6

Explanation / Answer

Answer a

Note : Since the company don't want to reduce its current level of operating income , thus for special order , the company will bid the minimum price which is equal to the cost to be incure for the special order (ie all the cost mentioned in question except variable sales commission)

Lowest bid price = Direct materials + Direct labor + Variable manufacturing overhead

= $9 + $8 + $7 = $24

Answer b

Let the bid per unit be $X

Per unit cost =  $9 + $8 + $7 + ( $ X * 4 %) = $24 + $0.04 X

Contribution margin ratio = (Bid price per unit - per unit cost) / Bid price per unit

[$ X - ($24 + $0.04 X)] / $ X = (0.96 X - 24) / X

Contribution Margin given in question = 36 % or 0.36.

Thus we can form the following equation .

(0.96 X - 24) / X = 0.36.

or , 0.96 X - 24 = 0.36. X

or , 0.60 X = 24

or , X = 40

Thus , bid price per unit = $40.

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