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 32,000-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 37 direct labor-hours and the following chemicals:

Chemicals	Quantity in Pounds
AG-5	350
KL-2	250
CW-7	150
DF-6	250

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 $0.12 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 $480.

Inventory and cost data for the chemicals that can be used to produce the Zwinger compound are shown below:

Raw Material	Pounds in Inventory	Actual Price per Pound When Purchased	Current Market Price per Pound
AG-5	19,000	$0.71	$0.81
KL-2	4,400	$0.41	$0.46
CW-7	8,400	$1.39	$1.59
DF-6	6,500	$0.56	$0.51
BH-3	5,400	$0.71	(Salvage)

      

The current direct labor wage rate is $14 per hour. The predetermined overhead rate is based on direct labor-hours (DLH). The predetermined overhead rate for the current year, based on a two-shift capacity with no overtime, is as follows:

Variable manufacturing overhead	$	4.20	per DLH
Fixed manufacturing overhead		8.30	per DLH
Combined predetermined overhead rate	$	12.50	per DLH

Wesco’s production manager reports that the present equipment and facilities are adequate to manufacture the Zwinger compound. Therefore, the order would have no effect on total fixed manufacturing overhead costs. However, Wesco is within 460 hours of its two-shift capacity this month. Any additional hours beyond the 460 hours must be done in overtime. If need be, the Zwinger compound could be produced on regular time by shifting a portion of GrowNWeed production to overtime. Wesco’s direct labor wage rate for overtime is $21 per hour. There is no allowance for any overtime premium in the predetermined overhead rate.

Required:

1. Wesco has decided to submit a bid for the 32,000 pound order of Zwinger’s new compound. The order must be delivered by the end of the current month. Zwinger has indicated that this is a one-time order that will not be repeated. Calculate the lowest price that Wesco could bid for the order without reducing its net operating income. (Round intermediate calculations and final answer to 2 decimal places.)

2. Refer to the original data. Assume that Zwinger Nursery plans to place regular orders for 32,000-pound lots of the new compound. Wesco expects the demand for GrowNWeed to remain strong. Therefore, the recurring orders from Zwinger would put Wesco over its two-shift capacity. However, production could be scheduled so that 60% of each Zwinger order could be completed during regular hours. As another option, some GrowNWeed production could be shifted temporarily to overtime so that the Zwinger orders could be produced on regular time. Current market prices are the best available estimates of future market prices.

Wesco’s standard markup policy for new products is 40% of the full manufacturing cost, including fixed manufacturing overhead. Calculate the price that Wesco, Inc., would quote Zwinger Nursery for each 32,000 pound lot of the new compound, assuming that it is to be treated as a new product and this pricing policy is followed. Hint: Calculate the price considering the possibility of this order being regular. (Round intermediate calculations and final answer to 2 decimal places.)

Answer 1

Part 1

The lowest price Wesco could bid for the one-time special order of 32,000 pounds (32 lots) without losing money would be $46406.80 as shown below:

  

Direct materials:
AG-5: 350 pounds per lot × 32 lots = 11200 pounds.     Substitute BH-3 on a one-for-one basis to its total of 5,400 pounds. If BH-3 is not used in     this order, it will be salvaged for $480. Therefore, the relevant cost is	$	480.00
The remaining 5800 (11200-5400) pounds would be AG-5 at a cost of $0.81 per pound		4698.00
KL-2: 250 pounds per lot × 32 lots = 8,000 pounds at $0.46 per pound		3680.00
CW-7: 150 pounds per lot × 32 lots = 4,800 pounds at $1.59 per pound		7632.00
DF-6: 250 pounds per lot × 32 lots = 8000 pounds. Use 6500 pounds in inventory at   $0.45 per pound ($0.51 market price – $0.12 handling charge), purchase the remaining 1,500   pounds at $0.51 per pound		3300.00
Total direct materials cost	$	19790.00
Direct labor: 37 DLHs per lot × 32 lots = 1,184 DLHs. Because only 460 hours can be    scheduled during regular time this month, overtime would have to be used for the    remaining 804 hours.
460 DLHs × $14.00 per DLH	$	6440.00
724 DLHs × $21.00 per DLH		15204.00
Total direct labor cost	$	21644.00
Overhead: This special order will not increase fixed overhead costs. Therefore, only the    variable overhead is relevant.
1,184 DLHs × $4.20 per DLH	$	4972.80
Total relevant cost of the special order	$	46406.80

  
2.

In this part, we calculate the price for recurring orders of 32,000 pounds (32 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: 11200 pounds × $0.81 per pound	$	9072.00
KL-2: 8,000 pounds × $0.46 per pound		3680.00
CW-7: 4800 pounds × $1.59 per pound		7632.00
DF-6: 8000 pounds × $0.51 per pound		4080.00
Total direct materials cost	$	24464.00
Direct labor: 60% (i.e., 710 DLHs) of the production of a batch can be done on regular     time; but the remaining production (i.e., 474 DLHs) must be done on overtime.
Regular time 710 DLHs × $14.00 per DLH	$	9,940.00
Overtime premium 474 DLHs × $21.00 per DLH		9,954.00
Total direct labor cost	$	19,894.00
Overhead: The full manufacturing cost includes both fixed and variable manufacturing     overhead.
Manufacturing overhead applied:       1,184 DLHs × $12.50 per DLH	$	14800.00
Full manufacturing cost	$	59158.00
Markup (40% × $59158)		23663.20
Selling price (full manufacturing cost plus markup)	$	82821.20