Billy Auto Parts (BAP) manufactures and sells auto parts for automakers and part distributors.

BAP is known for the quality of its parts and the reliability of its operations. The business however is very competitive with several competitors.

BAP just received an order from PROTO Holdings Berhad for 300 units of DX-50 – one of the engine components. PROTO is a major automobiles manufacturer. PROTO proposed a RM1,500 selling price per unit of DX-50. BAP applies a 10% mark-up on total cost to its auto parts.

Sales manager : We cannot afford to miss this business opportunity!

Production manager : As much as you eagerly want to accept PROTO’s proposal, I don’t think the price is favourable to us. It’s too low.

Sales manager : Are we going to let our competitors snatch this opportunity then? RM1,500 is just a starting point for negotiations. I believe PROTO is willing to pay a higher selling price for our quality reputation.

Accountant : Actually, we can take on cost-cutting to see if we can meet the price, but of course in correspondence to PROTO’s specifications.

A Value Assessment Team was formed specifically for the cost reduction program for part DX-50. An examination of the production costs by the accountant and team showed the following unit cost of DX-50 (based on average 10,000 production units per year):

Manufacturing RM1,600

General administrative RM250

Marketing RM100

The team discovered that a total of 40 tools were used to make DX-50. This can be reduced to 32 and that less expensive tools could be used on this auto part to meet PROTO’s product specifications. These changes could save RM200 of manufacturing cost per unit. The group also found that general administrative cost could be reduced by 30% through the use of electronic data interchange with suppliers and just-in-time (JIT) inventory management.
Marketing cost would not be incurred for this order. BAP has enough capacity to fulfil PROTO’s order.

Required:
a. Using BAP’s pricing policy, calculate:

i. the unit selling price of DX-50.

ii. the current gross profit per unit of DX-50.

b. Calculate BAP’s target cost for manufacturing DX-50 to meet PROTO’s proposed selling price.

c. Given the Value Assessment Team’s cost reduction outcomes,

i. will BAP meet its target cost? Explain.

ii. suppose PROTO is willing to increase the selling price by 5%, would you recommend BAP to accept the proposal? Why or why not?

d. Identify THREE factors, other than price, that BAP should consider before accepting PROTO’s proposal (please include an Islamic perspective in your answer).

e. Independent of Requirement (a) – (d). BAP is considering to invest in new technology for DX-50 production. If the plan is approved, BAP will have to invest RM1,000,000 in a special machine equipment. With the new technology, DX-50 is upgraded to a better quality, and it is expected that BAP to produce and sell 10,000 units of upgraded DX-50.

The new unit cost is estimated as follows:

Manufacturing RM1,800

General administrative RM300

Marketing RM120

If BAP requires a 30% return on investment (ROI), calculate the unit selling price of the upgraded DX-50, assuming BAP sets the selling price using a mark-up percentage on absorption cost.

f. When pricing products, many companies use target costing or cost-plus pricing methods. How does target costing differ from cost-plus pricing?