Advanced : Calculation of cost-plus price and minlumum short-run price plus a discussion of cost-plus and relevant cost pric ing Wright is a builder. His business will have spare capacity over the coming six months and he has been investigating two projects.

Project A Wright is tendering for a school extension contract. Normally he prices a contract bu adding 100% to direct costs. to cover ov'erheads and prof1t. He calculates direct costs as the actual cost of materials valued on a first-In-first-out basis. plus the esllmated wages of direct labour. But for this contract he has prepared more detailed information.

Four types of material will be needed.

Z andY are in regular use. Neither X nor W is currently used; X has no foreseeable use in the bus~ness. but W could be used on other jobs in place of material currently costing £16 per unit.
The contract will last for six months and requires two craftsmen.
whose basic annual wage cost is £16000 each. To complete the contract in time it will also be necesary to pay them a bonus of £700 each. Without the contract they would be retained at their normal pay rates. doing work which will otherwise be done by temporary workers engaged for the contract period at a total cost of £11 800.
Three casual labourers would also be employed specifically for the contract at a cost of £4000 each.
The contract will require two types of equipment: generalpurpose equipment already owned by Wright. which will be retained at the end of the contract, and specialised equipment to be purchased second-hand, which will be sold at the end of the contract The general-purpose equipment cost £21 000 two years ago and is being depreciated on a straight-line basis over a seven-year life (with assumed zero scrap value). Equivalent new equipment can be purchased currently for £49000. Second-hand prices for comparable general-purpose equipment. and those for the relevant specialised equipment. are shown below.

The contract will reqwe the use of a yard on which Wright has a four-year lease at a fixed rental of £2000 per year. If Wright does not get the contract the yard will probably remain empty. The contract will also incur administrative expenses estimated at £5000.
Project a If Wnght does not get the contract he will buy a building plot for £20 000 and build a house. Building costs will depend on weather conditions:

Similarly the price obtained for the house will depend on market conditions:

Wright does not have the resources to undertake both projects.
The costs of his supervision time can be ignored.
Requirements

(a) Ignoring the possibility of undertaking project B, calculate:
(i) the price at which Wright would tender for the school extension contract if he used his normal pricing method, and (ii) the tender price at which you consider Wright would neither gain nor lose by taking the contract. (10 marks)

(b) Explain. with supporting calculations, how the availability of proJect B should affect Wright's tender for the school extension contract (5 marks)

(c) Discuss the merits and limitations of the pricing methods used above. and identify the circumstances in which they m1ght be appropriate.

Transcribed Image Text:

Material Quantity (units): Needer for Already contract in stock Price per unit: Purchase Current Current price of units purchase resale in stock price price () () () NXXZ 1100 100 7.00 10.00 8.00 Y 150 200 40.00 44.00 38.00 600 300 35.00 33.00 25.00 W 200 400 20.00 21.00 10.00