The sales manager of Teak Plastics Limited (Teak), Naomi Moir, was concernedabout the company’s record in winning bids. Teak was a small manufacturer of high-pressure injection-molded plastic parts, supplied mainly to the automotive industry.
Over the past few years, Teak’s success in winning large contracts had steadily declined, forcing Teak to pursue greater numbers of small contracts. This has become aserious problem; the company’s total business has dropped to such an extent that it iscurrently operating at only 70% of capacity.Naomi realized that there was something wrong with her method of preparingbids. In the past year, Naomi found that the rate of success in winning bids increasedas the total size of the contract decreased. In her attempt to increase the totalamount of sales for Teak during the past year, she had submitted almost double thenumber of bids compared to previous years. This resulted in two people from theaccounting department spending most of their time preparing the cost data forNaomi’s bids.
The teak used a standard full-cost accounting system, and bids were prepared withthe objective of earning a 20% markup on total costs. Standard hourly operatingrates were developed using regression analysis of monthly prior-period costs foreach machine and process. These costs included all labor, job setup, and mold development costs as well as fixed and variable processing overhead costs. The jobsetup and mold development costs were fairly constant from job to job. The coefficients from the regression analysis were used as the rates for variable-cost items and the intercept values were divided by full capacity processing hours to determine therates for fixed-cost items.
At a recent business luncheon seminar, Naomi had been impressed by thespeaker’s model for preparing bids. This model involved using contributions, probabilities, and expected values. Accordingly, she decided to test the approach inpreparing her next bid for a fairly small contract for instrument panel components.She started with her usual bidding method based on the cost estimate prepared bythe accounting department (Exhibit 2-1), and made a mental note that she wouldnormally have submitted a bid of $141,000. She then made her best estimates of theprobabilities of winning the contract at various bids (Exhibit 2-2).

   

EXHIBIT 2-1 TEAK Cost Estimates for Contract to Supply 100,000 Automobile Instrument Panel Components Processing on machine 5: Variable Fixed Total machine processing costs Material Finishing: Variable Fixed Total manufacturing costs before rejects Rejects! Total manufacturing costs Selling and administration Total cost before royalty Markup (20%) Royalty of 10% of sales Standard price per unit Standard bid for 10,000 units Standard Hours 500 500 100 100 Standard Rate/Hour $51.50 35.50 23.50 28.50 Cost per Unit $ 2.575 1.775 4.350 4.463 0.235 0.285 9.333 0.933 10.266 0.337 10.603 2.121 12.724 1.414 $ 14.138 $141,380 A 10% standard allowance was added for defective units which would be rejected during final inspection. This reflected a normal spoilage rate. 2Selling and administration costs were all treated as fixed. A royalty of 10% of sales was payable to the inventor of machine 5, a very specialized machine. This contract would utilize 2% of Teak's total capacity.