CASE 2A–5 Analysis of Mixed Costs in a Pricing Decision [LO3, LO8]

Jasmine Lee owns a catering company that serves food and beverages at exclusive parties and busi- ness functions. Lee’s business is seasonal, with a heavy schedule during the summer months and holidays and a lighter schedule at other times.

One of the major events that Lee’s customers request is a cocktail party. She offers a standard cocktail party and has estimated the cost per guest for this party as follows:

 

Food and beverages . . . . . . . . . . . . . . . . . . . . . . . . . . .	$17.00
Labor (0.5 hour @ $10.00 per hour) . . . . . . . . . . . . . . .	5.00
Overhead (0.5 hour @ $18.63 per hour) . . . . . . . . . . . .	9.32
Total cost per guest . . . . . . . . . . . . . . . . . . . . . . . . . . . .	$31.32

 

This standard cocktail party lasts three hours and Lee hires one worker for every six guests, which is one-half hour of labor per guest. These workers are hired only as needed and are paid only for the hours they actually work.

Lee ordinarily charges $45 per guest. She is confident about her estimates of the costs of food and beverages and labor, but is not as comfortable with the estimate of overhead cost. The $18.63

 

 

 

 

overhead cost per labor-hour was determined by dividing total overhead expenses for the last 12 months by total labor-hours for the same period. Monthly data concerning overhead costs and labor-hours appear below:

 

 

 

Month

 

Labor Hours

 

Overhead Expenses

 

 

January . . . . . . . . . . . . . . . .	1,500	Â	$  44,000
February . . . . . . . . . . . . . . .	1,680	Â	47,200
March . . . . . . . . . . . . . . . . .	1,800	Â	48,000
April . . . . . . . . . . . . . . . . . . .	2,520	Â	51,200
May . . . . . . . . . . . . . . . . . . .	2,700	Â	53,600
June . . . . . . . . . . . . . . . . . .	3,300	Â	56,800
July . . . . . . . . . . . . . . . . .  .	3,900	Â	59,200
August . . . . . . . . . . . . . . . . .	4,500	Â	61,600
September . . . . . . . . . . . . .	4,200	Â	60,000
October . . . . . . . . . . . . . . . .	2,700	Â	54,400
November . . . . . . . . . . . . . .	1,860	Â	49,600
December . . . . . . . . . . . . . .	3,900	Â	58,400
Total . . . . . . . . . . . . . . . . . .	34,560	Â	$644,000

 

 

Lee has received a request to bid on a 120-guest fund-raising cocktail party to be given next month by an important local charity. (The party would last the usual three hours.) She would like to win this contract because the guest list for this charity event includes many prominent individuals that she would like to land as future clients. Lee is confident that these potential customers would be favorably impressed by her company’s services at the charity event.

Required:

1.       Prepare a scattergraph plot that puts labor-hours on the X-axis and overhead expenses on the

Y-axis. What insights are revealed by your scattergraph?

2.       Use the least-squares regression method to estimate the fixed and variable components of over- head expenses.

3.       Estimate the contribution to profit of a standard 120-guest cocktail party if Lee charges her usual price of $45 per guest. (In other words, by how much would her overall profit increase?)

4.       How low could Lee bid for the charity event, in terms of a price per guest, and still not lose money on the event itself?

5.       The individual who is organizing the charity’s fund-raising event has indicated that he has already received a bid under $42 from another catering company. Do you think Lee should bid below her normal $45 per guest price for the charity event? Why or why not?

(CMA, adapted)