5. Relevant Costs (2096) George Jettson builds custom homes in Cincinnati. Jetts

ID: 2556309 • Letter: 5

Question

5. Relevant Costs (2096) George Jettson builds custom homes in Cincinnati. Jettson was approached not too long ago by a client about a potential project, and he submitted a bid of $590,000, derived as follows: Land Construction materials Subcontractor labor costs S 90,000 120,000 150,000 S360,000 72,000 40,000 $472,000 Construction overhead: 20% of direct costs Allocated corporate overhead Total cost Jetson 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 SI 18,000 (S472.000 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 Jettson accept the client's offer? Why? handle, how much should he be willing to accept for B. If Jettson has more business than he can the home? Why?

Explanation / Answer

Land

$ 90,000

Construction Material

$ 120,000

Subcontractor labor Costs

$ 150,000

$ 360,000

Construction Overhead

$ 72,000

Allocated Corporate Overhead

$ 40,000

Less: Fixed Portion @ 60%

$ 24,000

$ 16,000

Total Relevant Costs

$ 448,000

Counter Offer

$ 455,000

Profit on Contract

$ 7,000

As the fixed portion of the construction overhead will accrue whether or not the contraact is accepted, it is an irrelevant cost while taking the decision. The business is slow and therefore the Company should accept any opportunity above its costs