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Cost-plus Pricing: Calculate Selling Price, Net Income, ROI

Construction on the Atlantis Full-Service Car Wash is nearing completion. The owner is Jay Leer, a retired accounting professor. The car wash is strategically located on a busy street that separates an affluent suburban community from a middle-class community. It has two state-of-the-art stalls. Each stall can provide anything from a basic two-stage wash and rinse to a five-stage luxurious bath. It is all "touchless," that is, there are no brushes to potentially damage the car. Outside each stall there is also a 400 horse-power vacuum. Jay likes to joke that these vacuums are so strong that they will pull the carpet right out of your car if you aren't careful.

Jay has some important decisions to make before he can open the car wash. First, he knows that there is one drive-through car wash only a 10-minute drive away. It is attached to a gas station; it charges $5 for a basic wash, and $4 if you also buy at least 8 gallons of gas. It is a "brush" type wash with rotating brush heads. There is also a self-service "stand outside your car and spray until you are soaked" car wash a 15-minute drive away from Jay's location. He went over and tried this out. He went through $3 in quarters to get the equivalent of a basic wash. He knows that both of these locations always have long lines, which is one reason why he decided to build a new car wash.

Jay is planning to offer three levels of wash service--Basic, Deluxe, and Premium. The Basic is all automated; it requires no direct intervention by employees. The Deluxe is all automated except that at the end an employee will wipe down the car and will put a window treatment on the windshield that reduces glare and allows rainwater to run off more quickly. The Premium level is a "pampered" service. This will include all the services of the Deluxe, plus a special wax after the machine wax, and an employee will vacuum the car, wipe down the entire interior, and wash the inside of the windows. To provide the Premium service, Jay will have to hire a couple of "car wash specialists" to do the additional pampering.

Jay has pulled together the following estimates, based on data he received from the local Chamber of Commerce and information from a trade association.

Per Unit Total
Direct materials per Basic wash $0.25
Direct materials per Deluxe wash $0.75
Direct materials per Premium wash $1.05
Direct labor per Basic wash na
Direct labor per Deluxe wash $0.40
Direct labor per Premium wash $2.40
Variable overhead per Basic wash $0.10
Variable overhead per Deluxe and Premium washes $0.20
Fixed overhead $112,500
Variable selling and administrative expenses all washes $0.10
Fixed selling and administrative expenses $121,500

The total estimated number of washes of any type is 45,000. Jay has invested assets of $324,000. He would like a return on investment (ROI) of 25%.

Answer each of the following questions:
(a) Identify the issues that Jay must consider in deciding on the price of each level of service of his car wash. Also discuss what issues he should consider in deciding on what levels of service to provide.
(b) Jay estimates that of the total 45,000 washes, 20,000 will be Basic, 20,000 will be Deluxe, and $5.000 will be Premium. Calculate the selling price, using cost-plus pricing, that Jay should use for each type of wash to achieve his desired ROI of 25%.
(c) During the first year, instead of selling 45,000 washes, Jay sold 43,000 washes. He was quite accurate in his estimate of first-year sales; he was way off on the types of washes that he sold. He sold 3,000 Basic, 31,000 Deluxe, and 9,000 Premium. His actual total fixed expenses were as he expected, and his variable cost per unit was as estimated. Calculate Jay's actual net income and his actual ROI. (Round to two decimal places.)
(d) Jay is using a traditional approach to allocate overhead. As a consequence, he is allocating overhead equally to all three types of washed, even though the Basic wash is considerably less complicated and uses very little of the technical capabilities of the machinery. What should Jay do to determine more accurate costs per unit? How will this affect his pricing and consequently, his sales?

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Cost-Plus Pricing

In a noncompetitive environment, the company is faced with the task of setting its own price, which is commonly a function of the cost of the product or service. The typical approach is to use cost-plus pricing which involves establishing a cost base and adding to this cost base a markup to determine a target selling price. The size of the markup depends on the desired operating income return on investment ...

Solution Summary

This solution is comprised of a Managerial Accounting problem that deals with Cost-Plus Pricing. The topic includes the following:

Identifying and discussing the issues in deciding on price.
How to calculate the selling price, using cost-plus pricing.
How to calculate the actual net income and actual ROI.
What to do to determine a more accurate cost per unit.

The problem shown here are taken from Managerial Accounting, 4th ed., Wiley Publishing, however, the detail step-by-step explanation of the topic provides students with a clear understanding of the concepts. Thank you for using Have a great day!