Prices are set in accordance with a cost-based formula. Costs of direct labour and raw materials are traced to each customer, and marked up at rates of 60% and 70% respectively. Production overhead is marked up by 50% and then allocated to customers in proportion to direct labour cost. Because these markup percentages are slightly lower than those applied by its competitors, Mhuru Ltd. has long believed that this pricing formula should enable it to retain the loyalty of its three customers. The Marketing Director was therefore surprised recently when he learned that one customer considered prices to be too high and was seriously considering taking his business elsewhere. Production overhead costs last month were made up of the following three elements: Activity Driver Cost Determining customer requirements Number of liaison meetings _8000 Making design changes Number of design changes _6000 Machine set-up Number of production batches _4000 Total = _18000 The following is a summary of the work carried out last month on behalf of the three customers: Customer A Customer B Customer C Total Direct labour cost $ _2700 _5500 _3800 _12000 Raw material cost $ _3200 _5000 _2800 _11000 Number of liaison meetings 12 9 11 32 Number of design changes 13 15 22 50 Number of production batches 7 10 3 20 REQUIRED: (a) Calculate the amount of profit which Mhuru Ltd. earned from each of its three customers last month. (16 marks) (b) Explain which customer is most likely to be unhappy with Mhuru’s pricing arrangements, and recommend what steps Mhuru Ltd. should take in order to retain this customer. (4 marks) (c) Briefly explain how the implementation of a life cycle costing approach to manufacturing can be a major source of competitive advantage. (5 marks)
Prices are set in accordance with a cost-based formula. Costs of direct labour and raw materials are traced to each customer, and marked up at rates of 60% and 70% respectively. Production overhead is marked up by 50% and then allocated to customers in proportion to direct labour cost. Because these markup percentages are slightly lower than those applied by its competitors, Mhuru Ltd. has long believed that this pricing formula should enable it to retain the loyalty of its three customers. The Marketing Director was therefore surprised recently when he learned that one customer considered prices to be too high and was seriously considering taking his business elsewhere. Production overhead costs last month were made up of the following three elements: Activity Driver Cost Determining customer requirements Number of liaison meetings _8000 Making design changes Number of design changes _6000 Machine set-up Number of production batches _4000 Total = _18000 The following is a summary of the work carried out last month on behalf of the three customers: Customer A Customer B Customer C Total Direct labour cost $ _2700 _5500 _3800 _12000 Raw material cost $ _3200 _5000 _2800 _11000 Number of liaison meetings 12 9 11 32 Number of design changes 13 15 22 50 Number of production batches 7 10 3 20 REQUIRED: (a) Calculate the amount of profit which Mhuru Ltd. earned from each of its three customers last month. (16 marks) (b) Explain which customer is most likely to be unhappy with Mhuru’s pricing arrangements, and recommend what steps Mhuru Ltd. should take in order to retain this customer. (4 marks) (c) Briefly explain how the implementation of a life cycle costing approach to manufacturing can be a major source of competitive advantage. (5 marks)
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