Question

Use this information to answer the next two questions.

Price Ceiling	$11,500,000
Target Price	$10,850,000
Estimated Cost	$10,000,000
Target Profit (8.5%)	$850,000
Final Cost	$9,600,000
Difference	$400,000 Under Run

A) Consider the side of the supplier. What is the cost plus profit for a cost reduction of $80,000 if the sharing arrangement is 80/20?

B) What is the cost plus profit if there is a cost over run of $70,000 and the sharing arrangement is 75/25?

Answer 1

1.Target Cost = $10,000,000

2.Target Profit= $850,000

Solution to Question A : Actual Cost is less than the Target Cost

Given cost reduction =$80,000

Supplier share of savings = 20%($80,000) = $16000/-

Total Contract cost= Actual cost + Target Profit +/- Seller's share

=($10,000,000-$80,000)+$850000+$16000

=$10,786,000/-

Solution to Question B: Actual Cost is more than the Target Cost

In Fixed Price Incentive fee, there's a ceiling price, the buyer will never pay above this price. The seller's profit decreases as the costs rises above the target cost. Once it hits the ceiling, the buyer will no longer share the cost overrun, any cost overrun from that point onward will be totally absorbed by the seller. If the cost overrun goes beyond the ceiling price, the seller will suffer a loss.

Given cost overrun = $70,000.

Supplier has spent $70,000 and this has to be shared between supplier and buyer in the ratio 25:75

Supplier share= $70,000*0.25 = $17,500/-

Total Contract cost= Actual cost + Target Profit +/- Seller's share

=($10,000,000+$70,000)+$850000-$17500

=$10,902,500/-