Bair Company is a manufacturer of standard and custom-designed bottling
equipment. Early in December 20x0 Lyan Company asked Bair to quote a
price for a custom-designed bottling machine to be delivered in April.
Lyan intends to make a decision on the purchase of such a machine by
January 1, so Bair would have the entire first quarter of 20x1 to build
the equipment. Bair’s pricing policy for custom-designed equipment is 50
percent markup on absorption manufacturing cost. Lyan’s specifications
for the equipment have been reviewed by Bair’s Engineering and Cost
Management departments, which made the following estimates for direct
material and direct labor.
Direct material ............................................ $307,200
Direct labor (11,000 hours at $18) .................. 198,000
Manufacturing overhead is applied on the basis of direct-labor hours. Bair normally plans to run
its plant at a level of 15,000 direct-labor hours per month and assigns
overhead on the basis of 180,000 direct-labor hours per year. The
overhead application rate for 20x1 of $10.80 per hour is based on the
following budgeted manufacturing overhead costs for 20x1.
Variable manufacturing overhead ......................... $1,166,400
Fixed manufacturing overhead .............................. 777,600
Total manufacturing overhead ................... $1,944,000
Bair’s production schedule calls for 12,000 direct-labor hours per
month during the first quarter. If Bair is awarded the contract for the
Lyan equipment, production of one of its standard products would have to
be reduced. This is necessary because production levels can only be
increased to 15,000 direct labor hours each month on short notice.
Furthermore, Bair’s employees are unwilling to work overtime.
Sales of the standard product equal to the reduced production would be
lost, but there would be no permanent loss of future sales or customers.
The standard product for which the production schedule would be reduced
has a unit sales price of $14,400 and the following cost structure.
Direct material ....................................................................... $ 3,000
Direct labor (250 hours at $18) .............................................. 4,500
Manufacturing overhead (250 hours at $10.80) .................. 2,700
Total cost ...................................................................... $10,200
Lyan needs the custom-designed equipment to increase its bottle-making
capacity so that it will not have to buy bottles from an outside
supplier. Lyan Company requires 5,000,000 bottles annually. Its present
equipment has a maximum capacity of 4,500,000 bottles with a directly
traceable cash outlay cost of 18 cents per bottle. Thus, Lyan has had to
purchase 500,000 bottles from a supplier at 48 cents each. The new
equipment would allow Lyan to manufacture its entire annual demand for
bottles at a direct-material cost savings of 1.2 cents per bottle. Bair
estimates that Lyan’s annual bottle demand will continue to be 5,000,000
bottles over the next five years, the estimated life of the
special-purpose equipment.
Required:
Bair Company’s management plans to submit a bid to Lyan Company for the manufacture of the special-purpose bottling equipment.
1. Calculate the bid Bair would submit if it follows its standard pricing policy for special-purpose equipment.
2. Calculate the minimum bid Bair would be willing to submit on the
Lyan equipment that would result in the same total contribution margin
as planned for the first quarter of 20x1.
3. Suppose Bair has submitted a bid slightly above the minimum
calculated in requirement (2). Upon receiving Bair’s bid, Lyan’s
assistant purchasing manager telephoned his friend at Tygar Corporation:
“Hey Joe, we just got a bid from Bair on some customized equipment. I
think Tygar would stand a good chance of beating it. Stop by the house
this evening, and I’ll show you the details of Bair’s bid and the
specifications on the machine.” Is Lyan Company’s assistant purchasing
manager acting ethically? Explain.
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