Suppose Jackson Jets is a small company that customizes Learjets for wealthy clients. At present, the company’s managers are negotiating with three potential customers for next year’s sales. The company’s accountants summarized cost information for each plane as follows:
The unavoidable costs are the overhead costs to customize the jets, such as facility costs (rent, amortization, etc.) and equipment-related costs. These costs are primarily fixed. The company has a policy of calculating price by applying a 50% mark-up on cost. Two potential cost-based pricing schemes follow.
REQUIRED
A. Calculate the selling price for each model under both alternatives, A and B.
Alternative A. Under this alternative, unavoidable costs are allocated to the three contracts equally, and a mark-up of 50% is added to total costs.
Alternative B. Under this alternative, unavoidable costs are allocated to each contract based on its proportion of avoidable costs, and then a mark-up of 50% is added to total costs.
B. Which alternative would you recommend? Would you want any additional information before making this decision?
C. Companies also face uncertainty in determining an appropriate mark-up percentage. Why is the mark-up 50% and not 20%, 30%, or some other amount? What should the mark-up be if only avoidable costs are included in the calculation? Most importantly, what are customers willing to pay?
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