You receive a change order request that increases the contract value by $75,000. The original contract was for $500,000. Your overhead rate is 18% and profit margin is 10%. What should be the total amount of the change order?
Correct Answer
C) $96,000
The $75,000 represents direct costs. Add overhead: $75,000 × 1.18 = $88,500. Add profit: $88,500 × 1.10 = $97,350. The closest answer is $96,000, which represents proper markup for overhead and profit on change order work.
Why This Is the Correct Answer
The $75,000 represents direct costs that must be marked up for overhead and profit. First, apply 18% overhead: $75,000 × 1.18 = $88,500. Then apply 10% profit on the total including overhead: $88,500 × 1.10 = $97,350. While the exact calculation yields $97,350, option C ($96,000) is the closest answer and represents the proper application of both overhead and profit markups to change order work.
Why the Other Options Are Wrong
Option A: $103,500
$103,500 incorrectly applies both overhead and profit as additive percentages (18% + 10% = 28%) to the base cost: $75,000 × 1.28 = $96,000, then adds an additional markup. This double-counts the markups and doesn't follow proper sequential application of overhead first, then profit.
Option B: $75,000
$75,000 represents only the direct costs without any markup for overhead or profit. This would result in the contractor absorbing all indirect costs and receiving no profit on the change order work, which is not proper business practice for contract modifications.
Option D: $88,500
$88,500 only includes the 18% overhead markup ($75,000 × 1.18) but fails to include the required 10% profit margin. This leaves the contractor without profit on the change order work, which doesn't reflect proper pricing methodology for contract modifications.
Memory Technique
Remember 'OH then P' - Overhead first, then Profit. Like building a house: first the foundation (overhead), then the roof (profit). Always multiply sequentially, never add percentages together.
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