BFR is a ship-building firm that has just won a government contract to build 10 high-speed patrol boats for the Coast Guard for drug interdiction and surveillance. Besides building ships for the gov- ernment, BFR has a commercial vessel division that designs and manufactures commercial fishing Cost Allocation: Theory 323 and commuting ships. The commercial division and the government division are the only two divisions of BFR, and the Coast Guard contract is the only work in the government division. The Coast Guard contract is a cost-plus contract. BFR will be paid its costs plus 5 percent of total costs to cover profits. Total costs include all direct materials, direct labor, purchased subassem blies (engines, radars, radios, etc.), and overhead. Overhead is allocated to the Coast Guard contract based on the ratio of direct labor expense on the contract to firmwide direct labor BFR can either purchase the engines from an outside source or build them internally. The following table describes the costs of the commercial division and the Coast Guard contract if the engines are built by BFR versus purchased outside. BFR Cost Structure (S in Millions) Coast Guard Contract (Engines Manufactured Internally Coast Guard Contract (Engines Purchased Externally) Commercial Division Direct labor Direct material Purchased engines $22.800 32.900 0.000 $14.600 $18.200 25.900 17.000 Overhead for BFR is $83.5 million and does not vary if the engines are purchased outside or manufactured inside BFR. Overhead consists of corporate-level salaries, building depreciation, property taxes, insurance, and factory administration costs. Required: a. How much overhead is allocated to the Coast Guard contract if (1) The engines are manufactured internally? b. Based on the total contract payment to BFR, will the Coast Guard prefer BFR to c. What is the difference in net cash flows to BFR of manufacturing versus purchasing the d. Explain how cost-plus reimbursement contracts in the defense industry affect the make- (2) The engines are purchased outside? manufacture or purchase the engines? engines? buy decision for subassemblies