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Delicious77 [7]
2 years ago
15

Before negotiating a long-term construction contract, build- ing contractors must carefully estimate the total cost of completin

g the project. Benzion Barlev of New York University proposed a model for total cost of a long-term contract based on the normal distribution(Journal of Business Finance and Accounting, July 1995). For one particular construction contract, Barlev assumed total cost, x, to be normally distributed with mean $850,000 and standard deviation $170,000. The revenue, R, promised to the contractor is $1,00,000.
Required:
a. The contract will be profitable if revenue exceeds total cost. What is the probability that the co ntract will be profitable for the contractor?
b. What is the probability that the project will result in a loss for the contractor?
c. Suppose the contractor has the opportunity to renegotiate the contract. What value of R should the contractor strive for in order to have a .99 probability of making a profit?
Business
1 answer:
zysi [14]2 years ago
7 0

Answer:

<h3>Benzion Barlev of New York University</h3>

NEGOTIATION OF A LONG-TERM CONSTRUCTION CONTRACT

a. The probability that the contract will be profitable for the contractor is:

= 81%

b. The probability that the project will result in a loss for the contractor is:

= 19%

c. The value of R that the contractor should strive for in order to have a .99 probability of making a profit is:

= $1,246,100.

Explanation:

a) Data and Calculations:

Mean total cost (x) = $850,000

Standard deviation = $170,000

Revenue = $1,000,000

Probability of being profitable = (R - x)/std deviation

= ($1,000,000 - $850,000)/$170,000

= $150,000/$170,000

= 0.882

From Z table, 0.882 = 0.81057 = 81%

Probability of loss = 19% (100 - 81%)

To have a 99% (0.99) probability of making a profit, Z value = 2.33 from the Z table:

(R - x)/std deviation = 2.33

(R - x) = 2.33 * $170,000

= $396,100

(R - $850,000) = $396,100

R = $396,100 + $850,000

R = $1,246,100

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<h3>Cost of Goods Manufactured Schedule</h3>

Work in process (1/1)                             $222,600

Direct materials:

Raw materials inventory (1/1)                 $ 47,300

Add: Raw materials purchases              168,000

Total raw materials available for use $215,300

Less: Raw materials inventory (12/31)     24,500

Direct materials used                          $190,800

Direct labor                                          $114,500

Manufacturing overhead:

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Factory depreciation   37,900

Factory utilities             72,600

Total overhead                                       130,100

Total manufacturing cost                  $658,000

Total cost of work in process           $658,000

Less: Work in process (12/31)                85,600

Cost of goods manufactured            $572,400

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The Schedule of Cost of Goods Manufactured shows the costs of:

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