Tag (SQ): Overhead absorption

Nexco Industries Limited makes Product Z in department C. For the year commencing 1 January Year 7, the following budget has been formulated for department C:

Note: This revenue is from budgeted sales of 20,000 units.
Production overheads are absorbed on the basis of 100% of direct costs. However, half of these costs are fixed, and the other half are variable. It is assumed that they vary with the cost of materials.
The administrative and marketing overheads are based on 25% of factory costs and do not vary within wide ranges of activity. A profit margin of 20% is applied to the full cost of sale. This also results in a price that appears to be fair to customers.
Halfway through the year to 31 December Year 7, it became clear that actual sales of Product Z would be 25% below budget. At about the same time that this shortfall in sales became evident, a customer asked about buying 5,000 units of a simplified version of Product Z. If Nexco Industries Limited were to produce this simplified model for the customer, the direct material and labour costs would be lower. It is estimated that materials costing GH¢12,000 and direct labour of GH¢8,000 would be required to produce the 5,000 units. As the production could take place within the firm’s existing capacity, fixed costs would not be affected.

Required:
(a) Calculate the prices that Nexco Industries Limited should quote to the customer for each unit of the simplified product, assuming that the following pricing policies are applied:
(i) Full cost plus pricing, on the current basis.
(ii) A price that would enable the company to achieve its original budgeted profit.

(b) Give your advice on the price that should be quoted to the customer.