Haverhill Electronics (HE) has offered to supply the county government with one model of its security screening device at “cost plus 20 percent.” HE operates a manufacturing plant that can produce 22,000 devices per year, but it normally produces 20,000. The costs to produce 20,000 devices follow.
Total Cost Cost per
Materials $ 1,000,000 $ 50
Labor 2,000,000 100
Supplies and other costs that will vary with production 600,000 30
Indirect cost that will not vary with production 600,000 30
Variable marketing costs 400,000 20
Administrative costs (will not vary with production) 1,200,000 60
Totals $ 5,800,000 $290
Based on these data, company management expects to receive $348 (= $290 × 120 percent) per device for those sold on this contract. After completing 200 devices, the company sent a bill (invoice) to the government for $69,600 (= 200 devices × $348 per device).
The president of the company received a call from a county auditor, who stated that the per device cost should be as follows.
Materials $ 50
Supplies and other costs that will vary with production 30
Therefore, the price per device should be $216 (= $180 × 120 percent). The county government ignored marketing costs because the contract bypassed the usual selling channels.
What price would you recommend? Why? (Note: You need not limit yourself to the costs selected by the company or by the government auditor.)