22.9 Pennine Heating Systems Limited is a small heating and ventilation system company located in Dewsbury in
Question:
22.9 Pennine Heating Systems Limited is a small heating and ventilation system company located in Dewsbury in West Yorkshire. It provides customer-designed systems for small businesses. The systems are designed, manufactured and installed specially for each customer.
This means that each individual contract has to be priced separately.
The company has expanded rapidly in recent years but as it has done so, its overhead costs have continued to increase. The managing director, Ali Shah, has always insisted that contracts should be priced on an absorption cost basis. This was not a problem in the early days of the company. There was a considerable demand for what Pennine Systems was able to offer and customers accepted almost whatever it quoted for doing a particular job.
More recently, however, the demand for heating and ventilation systems had become less strong, competitors have come into the market, the national economy is in recession, and customers are much conscious about their costs than they used to be when the economy was expanding.
Thus, while Pennine’s reputation is good, it has to be particularly sensitive about the price that it charges its orders. Indeed, Ali senses that the company is beginning to lose some business because its quotations are too high. He wonders whether he should review its pricing system in order to make sure that it attracts sufficient business.
Ali was reminded of what he intended to do when a request for a quotation landed on his desk late one Friday night. On the Monday, he asked Hugh Rodgers, his production manager, to cost and price it. He had the results on the Wednesday morning. Hugh’s calculations were as follows.
Note: Factory overhead, administration overhead, and selling and distribution overhead is added to the factory cost of production at rates of 20%, 10% and 15% respectively. A profit loading of 20% is added to the total operating cost.
Ali suspects that a contract price of £100000 may be too high to gain the contract. He wonders whether the company can afford to accept a price lower than £100 000. He asks the production manager to conduct an intensive investigation of the cost build-up and other matters relating to the contract. Hugh does so and discovers, inter alia, the following information:
1 All of the overheads include a share of the fixed costs of the company. 75% of the factory overhead, 80% of the administration overhead, and 60% of the selling and distribution overhead are fixed costs.
2 Hugh has been informed privately that a number of other companies have been asked to quote for the contract and that three other companies are being considered at a contract price of £70000, £75000, and £95000 respectively.
Required:
1 Advise Ali Shah what price Pennine Heating Systems Limited should quote for the contract.
2 Outline what factors other than price Ali should take into account before offering a firm quotation.
Step by Step Answer:
