Reference no: EM13888871

Construction on the Bonita Full-Service Car Wash is nearing completion. The owner is Dave Kear, a retired accounting professor. The car wash is strategically located on a busy street that separates an affluent suburban community from a middle-class community. It has two state- of-the-art stalls. Each stall can provide anything from a basic two-stage wash and rinse to a five- stage luxurious bath. It is all "touchless," that is, there are no brushes to potentially damage the car. Outside each stall, there is also a 400 horse-power vacuum. Dave likes to joke that these vacuums are so strong that they will pull the carpet right out of your car if you aren't careful.

Dave has some important decisions to make before he can open the car wash. First, he knows that there is one drive-through car wash only a 10-minute drive away. It is attached to a gas station; it charges $5 for a basic wash, and $4 if you also buy at least 8 gallons of gas. It is a "brush"-type wash with rotating brush heads. There is also a self-serve "stand outside your car and spray until you are soaked" car wash a 15-minute drive away from Dave's location. He went over and tried this out. He went through $3 in quarters to get the equivalent of a basic wash. He knows that both of these locations always have long lines, which is one reason why he decided to build a new car wash.

Dave is planning to offer three levels of wash service-Basic, Deluxe, and Premium. The Basic is all automated; it requires no direct intervention by employees. The Deluxe is all automated ex- cept that at the end an employee will wipe down the car and will put a window treatment on the windshield that reduces glare and allows rainwater to run off more quickly. The Premium level is a "pampered" service. This will include all the services of the Deluxe, plus a special wax after the machine wax, and an employee will vacuum the car, wipe down the entire interior, and wash the inside of the windows. To provide the Premium service, Dave will have to hire a couple of "car wash specialists" to do the additional pampering.

Dave has pulled together the following estimates, based on data he received from the local Chamber of Commerce and information from a trade association.

	Per Unit	Total
Direct materials per Basic wash	$0.30
Direct materials per Deluxe wash	$0.80
Direct materials per Premium wash	$1.10
Direct labor per Basic wash	na
Direct labor per Deluxe wash	$0.40
Direct labor per Premium wash	$2.40
Variable overhead per Basic wash	$0.10
Variable overhead per Deluxe and Premium washes	$0.20
Fixed overhead		$117,000
Variable selling and administrative expenses all washes	$0.10
Fixed selling and administrative expenses		$130,500

The total estimated number of washes of any type is 45,000. Dave has invested assets of $393,750. He would like a return on investment (ROI) of 20%.

Instructions

Answer each of the following questions.

(a) Identify the issues that Dave must consider in deciding on the price of each level of service of his car wash. Also discuss what issues he should consider in deciding on what levels of service to provide.

(b) Dave estimates that of the total 45,000 washes, 20,000 will be Basic, 20,000 will be Deluxe, and 5,000 will be Premium. Calculate the selling price, using cost-plus pricing, that Dave should use for each type of wash to achieve his desired ROI of 20%.

(c) During the first year, instead of selling 45,000 washes, Dave sold 43,000 washes. He was quite accurate in his estimate of first-year sales, but he was way off on the types of washes that he sold. He sold 3,000 Basic, 31,000 Deluxe, and 9,000 Premium. His actual total fixed expenses were as he expected, and his variable cost per unit was as estimated. Calculate Dave's actual net income and his actual ROI.

(d) Dave is using a traditional approach to allocate overhead. As a consequence, he is allocating overhead equally to all three types of washes, even though the Basic wash is considerably less complicated and uses very little of the technical capabilities of the machinery. What should Dave do to determine more accurate costs per unit? How will this affect his pricing and, conse- quently, his sales?