PMI specializes in automobile modification. Recently it received a contract from a large Detroit auto manufacturer to modify 1,500 production cars with a high performance package, which will increase the cars horsepower and handling capabilities. For meeting the terms of the contract PMI will receive $2,150 per car.

The accountant for PMI has spent a week going over the contract and estimates the following costs:

• Direct labor, 33,000 hours at $18 per hour
• Parts needed form existing inventories originally cost $325,000. However, current replacement costs are $410,000.
• Additional necessary parts will be purchased at a cost of $750,000.
• A calibrated cylinder resurfacer will be required to increase engine compression. The machine rents for $65,000 for the life of the contract.
• To finance the six-month project PMI will need a loan of $600,000, and its current credit standing results in an interest rate of 12.5 percent.
• To consult on the project, a renowned Italian race car designer will be brought in at a cost of $39,000.
• Variable overhead costs are allocated to projects by a $5 charge per direct labor hour.
• To obtain the required return on capital, standard procedure at PMI is to charge a 75 percent profit margin on both direct labor costs and the purchase price of all materials used.

Slumping US auto sales over the last few years have resulted in excessive capacity at PMI. Thus acceptance of this contract will not interrupt present or future production schedules.

1. Which costs are relevant to PMIs decision? Is each cost explicit or implicit?
2. Should PMI accept or reject the auto modification contract?