Berg and Sons build custom made pleasure boats which range in price from \(\$ 10,000\) to \(\$ 250,000\). For the past 30 years, Mr. Berg, Sr. has determined the selling price of each boat by estimating the costs of material, labor, a prorated portion of overhead, and adding \(20 \%\) to these estimated costs.

For example, a recent price quotation was determined as follows:

The overhead figure was determined by estimating total overhead costs for the year and allocating them at \(25 \%\) of direct labor.
If a customer rejected the price and business was slack, Mr. Berg, Sr. would often be willing to reduce his markup to as little as \(5 \%\) over estimated costs. Thus, average markup for the year is estimated at \(15 \%\).
Mr. Ed Berg, Jr. has just completed a course on pricing and believes the firm could use some of the techniques discussed in the course. The course emphasized the contribution margin approach to pricing and Mr. Berg, Jr. feels such an approach would be helpful in determining the selling prices of their custom made pleasure boats. Total overhead which includes selling and administrative expenses for the year has been estimated at \(\$ 150,000\) of which \(\$ 90,000\) is fixed and the remainder is variable in direct proportion to direct labor.
{Required:}

(a) Assume the customer in the example rejected the \(\$ 18,000\) quotation and also rejected a \(\$ 15,750\) quotation ( \(5 \%\) markup) during a slack period. The customer countered with a \(\$ 15,000\) offer.
(1) What is the difference in net income for the year between accepting or rejecting the customers offer?

(2) What is the minimum selling price Mr. Berg, Jr. could have quoted without reducing or increasing net income?

(b) What advantages does the contribution margin approach to pricing have over the approach used by Mr. Berg, Sr.?

(c) What pitfalls are there, if any, to contribution margin pricing?

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Direct materials......... $ 5,000 Direct labor............... 8,000 Overhead........ 2,000 $15,000 Plus 20%......... 3,000 Selling price............ $18.000