Zylar Industries is a manufacturer of standard and custom-designed bottling equipment. Early in December 20x0, Lyan Company asked Zylar to quote a price for a custom-designed bottling machine to be delivered in April. Lyan intends to make a decision on the purchase of such a machine by January 1, so Zylar would have the entire first quarter of 20x1 to build the equipment. Zylar's pricing policy for custom-designed equipment is 50 percent markup on absorption manufacturing cost. Lyan's specifications for the equipment have been reviewed by Zylar's Engineering and Cost Management Departments, which made the following estimates for direct material and direct labor.

Direct material ............................................................................................................ $256,000

Direct labor (11,000 hours at $15) ................................................................................ 165,000

Manufacturing overhead is applied on the basis of direct-labor hours. Zylar normally plans to run its plant at a level of 15,000 direct-labor hours per month and assigns overhead on the basis of 180,000 direct-labor hours per year. The overhead application rate for 20x1 of $9.00 per hour is based on the following budgeted manufacturing overhead costs for 20x1.

Variable manufacturing overhead ............................................................................. $ 972,000

Fixed manufacturing overhead .................................................................................... 648,000

Total manufacturing overhead ................................................................................ $1,620,000

Zylar's production schedule calls for 12,000 direct-labor hours per month during the first quarter.

If Zylar is awarded the contract for the Lyan equipment, production of one of its standard products would have to be reduced. This is necessary because production levels can only be increased to 15,000 direct-labor hours each month on short notice. Furthermore, Zylar's employees are unwilling to work overtime.

Sales of the standard product equal to the reduced production would be lost, but there would be no permanent loss of future sales or customers. The standard product for which the production schedule would be reduced has a unit sales price of $12,000 and the following cost structure?

Direct material ...................................................................................................... $2,500

Direct labor (250 hours at $15) .............................................................................. 3,750

Manufacturing overhead (250 hours at $9) ............................................................ 2,250

Total cost .............................................................................................................. $8,500

Lyan needs the custom-designed equipment to increase its bottle-making capacity so that it will not have to buy bottles from an outside supplier. Lyan Company requires 5,000,000 bottles annually. Its present equipment has a maximum capacity of 4,500,000 bottles with a directly traceable cash outlay cost of 15 cents per bottle. Thus, Lyan has had to purchase 500,000 bottles from a supplier at 40 cents each. The new equipment would allow Lyan to manufacture its entire annual demand for bottles at a direct-material cost savings of 1 cent per bottle. Zylar estimates that Lyan's annual bottle demand will continue to be 5,000,000 bottles over the next five years, the estimated life of the special-purpose equipment.

Required:

Zylar Industries plans to submit a bid to Lyan Company for the manufacture of the special-purpose bottling equipment.

1. Calculate the bid Zylar would submit if it follows its standard pricing policy for special-purpose equipment.

2. Calculate the minimum bid Zylar would be willing to submit on the Lyan equipment that would result in the same total contribution margin as planned for the first quarter of 20x1.

3. Suppose Zylar Industries has submitted a bid slightly above the minimum calculated in requirement (2). Upon receiving Zylar's bid, Lyan's assistant purchasing manager telephoned his friend at Tygar Corporation: "Hey Joe, we just got a bid from Zylar Industries on some customized equipment. I think Tygar would stand a good chance of beating it. Stop by the house this evening, and I'll show you the details of Zylar's bid and the specifications on the machine."

Is Lyan Company's assistant purchasing manager acting ethically? Explain.