FlyWell Avionics produces sophisticated guidance systems that are used in military satellites. FlyWell currently is bidding on a government contract to supply 32 specialized guidance systems over the next two years. FlyWell estimates that the variable cost of the first guidance system will be $1,200,000, which is comprised of $600,000 in labor costs, $400,000 in material costs, and $200,000 in variable overhead (i.e., other variable manufacturing) costs. While the materials and variable overhead costs are expected to remain constant over the 32 guidance systems, FlyWell believes that labor costs will be subject to a 90% learning curve. That is, as workers become familiar with producing the new guidance system, they are expected to become more efficient in performing their duties. Consequently, the average labor hours and, in turn, labor costs per guidance system are expected to decrease as the number of guidance systems produced increases.

On this particular government contract, management of FlyWell plans to submit a bid that equals the total variable costs of producing the 32 guidance systems plus a 50% markup (i.e., the bid = 1.50 × total variable costs).

Required:

a. What are the total variable costs FlyWell expects to incur in producing the 32 guidance systems?

b. What is the bid that FlyWell plans to submit? If it wins the contract, what is FlyWell’s expected contribution margin from producing the 32 guidance systems?

c. Suppose that FlyWell obtains the contract but, due to budgetary pressures, the government is forced to scale back its order to 16 systems. Because the order size has been cut in half, the government is only willing to pay half of FlyWell’s bid calculated in part (b). What is the actual contribution margin and markup that FlyWell will realize from this contract?