option value of capacity Ralph' s Custom Produets (RCP) is a eustom manufaeturer of material handling equipment. V arious just-in-time manufaeturing systems require parts from suppliers that arrive in eontainers that are specialized to accommodate transportation and handling in the receiving faeility. RCP designs and manufaetures these containers.

A new eustomer has arrived, seeking a bid on a partieular set of containers. The RCP engineer provides the following estimates:

machine hours required direet labor hours required cost per hour of direet labor deRt. #1 150 120

$18 deRt. #2 200 350

$24 Notice RCP uses two manufaeturing departments. The direet labor rates inelude 20% fringe (covering various taxes, vaeations, and so on). Overheads in the two departments are budgeted with the following LLAs:

OVl = 150,000 + 14-MH and OV 2 = 200,000 + 45 -DLH, where MH refers to maehine hours in department #1 and DLH refers to direet labor hours in department #2. (Respeetive normal volumes are MH = 7,500 and DLH =

5,000.) In addition, the engineer estimates total direet material eost will be 12,000 and shipping costs will totaI4,000.

a] What are the full cost overhead applieation rates in the two departments?

b] What is the minimum price RCP should eonsider in negotiating with this new eustomer?

e] How does the cost datum derived in [b] above relate to the cost that would be reported in the accounting library? More preeisely, what produet cost would be recorded in the typieal accounting library?

d] Now suppose a eapacity problem might exist. One of RCP's usual eustomers might require some modifieation of containers in use. If so, taking on the new customer will use up slaek in department #2' s schedule that should be devoted to the existing customer base; and ifthis happens, RCP will be forced to subcontraet 200 direet labor hours, at a rate of 150 per hour. The sales force estimates the existing eustomer will require this modifieation with probability u. If RCP is risk neutral, what now is the minimum price it should consider in negotiating with this new customer?

AppendixLO1