Question

Jeff Heun,president of Concrete Always, agrees to construct a concrete cartpath at Dakota Golf Club. Concrete Always enters into a contractwith Dakota to construct the path for $200,000. In addition, aspart of the contract, a performance bonus of $40,000 will be paidbased on the timing of completion. The performance bonus will bepaid fully if completed by the agreed-upon date. The performancebonus decreases by $10,000 per week for every week beyond theagreed-upon completion date. Jeff has been involved in a number ofcontracts that had performance bonuses as part of the agreement inthe past. As a result, he is fairly confident that he will receivea good portion of the performance bonus. Jeff estimates, given theconstraints of his schedule related to other jobs , that there is55% probability that he will complete the project on time, a 30%probability that he will be 1 week late, and a 15% probability thathe will be 2 weeks late.
(a) Determine the transaction price that Concrete Always shouldcompute for this agreement.


(b) Assume that Jeff Heun has reviewed his work schedule anddecided that it makes sense to complete this project on time. Assuming that he now believes that the probability forcompleting the project on time is 90% and otherwise it will be finished 1 week late, determine the transaction price.

Answer 1

Answer:

a. $234,000

b. $239,000

Explanation:

a. The transaction price is

= Construction cost + Performance bonus on the time of completion × project complete on time percentage + performance bonus after one week × one week late percentage + performance bonus after two week × two week late percentage

= $200,000 + $40,000 × 0.55 + $30,000 × 0.30 + $20,000 × 0.15

= $200,000 + $22,000 + $9,000 + $3,000

= $234,000

b. The transaction price is

= Construction cost + Performance bonus on the time of completion × project complete on time probability + performance bonus after one week × one week late probability

= $200,000 + $40,000 × 90% + $30,000 × 10%

= $200,000 + $36,000 + $3,000

= $239,000

The after one week is

= $40,000 - $10,000

= $30,000

The after two week is

= $40,000 - $10,000 - $10,000

= $20,000