Question

After working for a software company for several years, Chris and Terry quit their jobs and set up their own consulting firm called C & T Software, Inc. Major customers include corporate, professional, and government organizations that are setting up information networks. The cost per billable hour of service at the company’s normal volume of 3,000 billable hours per month follows. (A billable hour is one hour billed to a client.) Average cost per hour billed to client: Variable labor—consultants $50 Variable overhead, including supplies and clerical support 20 Fixed overhead, including allowance for unbilled hours 80 $150 Marketing and administrative costs per billable hour (all fixed) 40 Total hourly cost $190 Treat each of the following questions independently. Unless given otherwise, the regular fee per hour is $200.How many hours must the firm bill per month to break even? (You may need to refer to Chapter 5 to answer this question.) b. Market research estimates that a fee increase to $250 per hour would decrease monthly volume to 2,000 hours. The accounting department estimates that fixed overhead costs would be $120 per hour, while variable cost per hour would remain unchanged. What effect would a fee increase have on profits? c. Assume C & T Software is operating at its normal volume of 3,000 hours per month. It has received a special request from one of its long-time customers to provide services on a special-order basis. Because of the long-term nature of the contract (four months) and the magnitude (1,000 hours per month), the customer believes a fee reduction is in order. C & T Software has a capacity limitation of 4,000 hours per month. Fixed costs would not change if the firm accepts the special order. What is the lowest fee C & T Software would be willing to charge?

Answer 1

a . Calculation of break even hours = fixed cost (wn 2) / contribution per hour (wn 1) = 360000/130 = 2769.23 hours

Working note :-

1 Calculation of Contribution per hour

Fee per hour	200
(-) variable cost
Variable labour consultant	(50)
Variable overhead including supplies and clerical support	(20)
Contribution per hour	$130

2 Calculation of fixed cost

Fixed overhead per hour	80
Marketing and administrative cost per hour	40
Total fixed cost per hour	120
X total billable hours	3000
Total fixed cost	$360000

b. Folowing would be the effect of increase in price on net profit :-

Increase in contribution on 2000 hours (50x2000)	100000
Loss of contribution on 1000 hours (130x1000)	(130000)
Decrease in profit	30000

Note :- fixed cost continues to remain fixed irrespective of change in hours. Thus, fixed cost is ignored.

c . Since we have capacity of 4000 hours and currently are utilizing 3000 hours of capacity. So we are still left with 1000 capacity which is actually required in this special order. Thus, minimum price to be charged would be only variable cost that are being incurred, since, fixed cost will not going to change in response to this special order

Since variable cost is $70 per billable hours

Thus, minimum fee to be charged by C&T software would be $70 per billable hour.