Intermediate: Acceptance of a contract JB Limited is a small specialist manufacturer of electronic components and much of its output is used by the makers of aircraft for both civil and military purposes. One of the few aircraft manu¬ facturers has offered a contract to JB Limited for the supply, over the next twelve months, of 400 identical components.

The data relating to the production of each component is as follows:

(i) Material requirements:

3 kg material Ml - see note 1 below 2 kg material P2 - see note 2 below 1 Part No. 678 - see note 3 below Note 1. Material Ml is in continuous use by the company. 1000 kg are currently held in stock at a book value of £4.70 per kg but it is known that future purchases will cost £5.50 per kg.

Note 2. 1200 kg of material P2 are held in stock. The original cost of this material was £4.30 per kg but as the material has not been required for the last two years it has been written down to £1.50 per kg scrap value. The only foreseeable alternative use is as a substi¬ tute for material P4 (in current use) but this would involve further processing costs of £1.60 per kg. The current cost of material P4 is £3.60 per kg.

Note 3. It is estimated that the Part No. 678 could be bought for £50 each.

(ii) Labour requirements: Each component would require five hours of skilled labour and five hours of semi-skilled. An employee possessing the necessary skills is available and is currently paid £5 per hour. A replacement would, however, have to be obtained at a rate of £4 per hour for the work which would otherwise be done by the skilled employee. The current rate for semi-skilled work is £3 per hour and an additional employee could be appointed for this work.

(iii)Overhead: JB Limited absorbs overhead by a machine hour rate, currently £20 per hour of which £7 is for variable overhead and £13 for fixed overhead. If this contract is undertaken it is estimated that fixed costs will increase for the duration of the contract by £3200. Spare machine capacity is available and each component would require four machine hours.

A price of £145 per component has been suggested by the large company which makes aircraft.

You are required to:

(a) State whether or not the contract should be accepted and support your conclusion with appropriate figures for presentation to management; (16 marks)

(b) comment briefly on three factors which management ought to consider and which may influence their decision. (9 marks)
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