Question

Peabody Construction Company enters into a contract with a customer to build a warehouse for $100,000, with a performance bonus of $50,000 that will be paid based on the timing of completion. The amount of the performance bonus decreases by 10% per week for every week beyond the agreed-upon completion date. The contract requirements are similar to contracts that Peabody has performed previously, and management believes that such experience is predictive for this contract. Management estimates that there is a 60% probability that the contract will be completed by the agreed-upon completion date, a 30% probability that it will be completed 1 week late, and only a 10% probability that it will be completed 2 weeks late.

Question:How should Peabody account for this revenue arrangement?

Answer 1

The correct answer is

Expected Value approach:

1_ 60% chance of receiving full bonus

100,000 +50,000 = 150,000

150,000 ×%60 = 90,000

2_ 30% chance of completing work one week late.

decrease by 10% per week upon late completio.

50,000× %90 = 45,000

100,000 + 45, 000 = 145,000

145,000 × %30 = 43,500

3_ 10% chance of completing 2 weeks late .

decrease by 10% each week *2= 20.

50,000 × %80 = 40,000

100,000+ 40,000 = 140,000

140,000 × %10 = 14,000

good luck ❤