Relevant cost of materials. The Hernandez Corporation is bidding on a new construction contract, here called Contract No. 1. If the bid is accepted, work will begin in a few days, on January 1, 2007. Contract No. 1 requires a special cement. Hernandez has already purchased 10,000 kilograms of the special cement for $20,000. The current purchase cost of the cement is $2.40 per kilogram. The company could sell the cement now for $1.60 per kilogram after all selling costs.
Hernandez will also bid on Contract No. 2 one month from now. If Contract No. 1 is not landed, the special cement will be available for Contract No. 2. If Contract No. 1 is landed, Hernandez will need to buy 10,000 kilograms of another grade of cement for $2.50 per kilogram to fulfill Contract No. 2.
Ifit is not used in either ofthese two ways, the special cement would be of no use to the company and would be sold a little more than a month from now for $1.50 per kilogram after all selling costs.
The president ofHernandez,Julio Gomez, is puzzled about the appropriate total cost ofthe special cement to be used in bidding on Contract No. 1. Competition is intense and markups are very thin, so determining the relevant material costs when bidding on Contract No. 1 is crucial.
Required 1. Suppose Gomez is certain that Hernandez will land Contract No. 2; what (relevant) cost fig¬
ure should Gomez use for the special cement when bidding on Contract No. 1?
2. This part requires knowledge of the material on decision making under uncertainty in the appendix to Chapter 3. Suppose Gomez estimates a probability of 0.7 that Hernandez will land Contract No. 2. What (relevant) cost figure should Gomez use for the special cement when bidding on Contract No. 1 ?
3. Suppose Hernandez could sell the special cement now for $2.30 per kilogram after all sell¬
ing costs (instead of $1.60 per kilogram described in paragraph 1). Suppose Gomez is cer¬
tain that Hernandez will land Contract No. 2. What (relevant) cost figure should Gomez use for the special cement when preparing a bid on Contract No. 1?