Question

Wesco Incorporated's only product is a combination fertilizer/weedkiller called GrowNWeed. GrowNWeed is sold nationwide to retail nurseries and garden stores. Zwinger Nursery plans to sell a similar fertilizer/weedkiller compound through its regional nursery chain under its own private label. Zwinger does not have manufacturing facilities of its own, so it has asked Wesco (and several other companies) to submit a bid for manufacturing and delivering a 20,000-pound order of the private brand compound to Zwinger. While the chemical composition of the Zwinger compound differs from that of GrowNWeed, the manufacturing processes are very similar. The Zwinger compound would be produced in 1,000-pound lots. Each lot would require 25 direct labor-hours and the following chemicals: Chemicals AG-5 KL-2 CW-7 DF-6 Quantity in Pounds 300 200 150 175 The first three chemicals (AG-5, KL-2, and CW-7) are all used in the production of GrowNWeed. DF-6 was used in another compound that Wesco discontinued several months ago. The supply of DF-6 that Wesco had on hand when the other compound was discontinued was not discarded. Wesco could sell its supply of DF-6 at the prevailing market price less $0.10 per pound selling and handling expenses. Wesco also has on hand a chemical called BH-3, which was manufactured for use in another product that is no longer produced. BH-3, which cannot be used in GrowNWeed, can be substituted for AG-5 on a one-for-one basis without affecting the quality of the Zwinger compound. The BH-3 in inventory has a salvage value of $600. Inventory and cost data for the chemicals that can be used to produce the Zwinger compound are shown below: Actual Price per Pound when Raw Material AG-5 KL-2 CW-7 DF-6 BH-3 Pounds in Inventory 18,000 6,000 7,000 3,000 3,500 Purchased $ 1.15 $1.10 $ 1.35 $ 0.80 $0.90 Current Market Price per Pound $1.20 $1.05 $1.35 $0.70 (Salvage)

Answer 1

1. The lowest price Wesco could bid for the one-time special order of 20,000 pounds (20 lots) without losing money would be $23,200, as shown below:

  Direct materials:

AG-5: 300 pounds per lot × 20 lots = 6,000 pounds. Substitute BH-3 on a one-for-one basis to its total of 3,500 pounds. If BH-3 is not used in this order, it will be salvaged for $600. Therefore, the relevant cost is	$ 600
The remaining 2,500 pounds would be AG-5 at a cost of $1.20 per pound	3,000
KL-2: 200 pounds per lot × 20 lots = 4,000 pounds at $1.05 per pound	4,200
CW-7: 150 pounds per lot × 20 lots = 3,000 pounds at $1.35 per pound	4,050
DF-6: 175 pounds per lot × 20 lots = 3,500 pounds. Use 3,000 pounds in inventory at $0.60 per pound ($0.70 market price – $0.10 handling charge), and purchase the remaining 500 pounds at $0.70 per pound	2,150
Total direct materials cost	14,000

  Direct labor: 25 DLHs per lot × 20 lots = 500 DLHs. Because only 400 hours can be scheduled during regular time this month, overtime would have to be used for the remaining 100 hours.

400 DLHs × $14.00 per DLH	5,600
100 DLHs × $21.00 per DLH	2,100
Total direct labor cost	7,700

  Overhead: This special order will not increase fixed overhead costs. Therefore, only the variable overhead is relevant.

500 DLHs × $3.00 per DLH

1,500

Total relevant cost of the special order

$23,200

2. In this part, we calculate the price for recurring orders of 20,000 pounds (20 lots) using the company’s rule of marking up its full manufacturing cost. This is not the best pricing policy to follow, but is a common practice in business.

  Direct materials: Because the initial order will exhaust existing inventories of BH-3 and DF-6 and new supplies would have to be purchased, all raw materials should be charged at their expected future cost, which is the current market price.

AG-5: 6,000 pounds × $1.20 per pound	$ 7,200
KL-2: 4,000 pounds × $1.05 per pound	4,200
CW-7: 3,000 pounds × $1.35 per pound	4,050
DF-6: 3,500 pounds × $0.70 per pound	2,450
Total direct materials cost	17,900

  Direct labor: 90% (i.e., 450 DLHs) of the production of a batch can be done on regular time; but the remaining production (i.e., 50 DLHs) must be done on overtime.

Regular time 450 DLHs × $14.00 per DLH	6,300
Overtime premium 50 DLHs × $21.00 per DLH	1,050
Total direct labor cost	7,350

  Overhead: The full manufacturing cost includes both fixed and variable manufacturing overhead.

Manufacturing overhead applied: 500 DLHs × $13.50 per DLH

6,750

Full manufacturing cost	32,000
Markup (40% × $32,000)	12,800
Selling price (full manufacturing cost plus markup)	$44,800