Class 3 (Week 4) 1. Machine Makers plc - Relevant cost Machine Makers plc (MM) makes specialist machinery to customers' specifications. Recently, just as MM completed a particular machine for a customer, it received information that the customer had gone bankrupt with no possibility of any payment to MM being seen as likely. The total contract price was f1 10,000. The contract specified that payment must be made in stages, as the machine's manufacture progressed. MM had received $60,000 in progress payments for the machine. It is estimated that the machine could be sold, as it stands, for $80,000. Another potential customer has been identified for the machine, but this would require alterations to it. Details of the alterations are as follows: (i) Material A The required quantity is held in inventories. This cost $6,000 when it was bought. It would cost $6,400 to replace it. The material is hazardous and would cost the business E1,000 to scrap it. The business uses it constantly. (ii) Material B By coincidence the appropriate quantity of this material was ordered recently for another contract that was subsequently abandoned because the material was not delivered in time. MM does not normally use this material and its scrap value is $4,000. The original cost price was agreed at f10,000. Though the contract to buy this material is binding, the supplier will accept 8,000 to compensate for the late delivery. The current market buying price is now $7,000. (iii) Material C 20 units of this material will be required. This is in general use in the business. An order for 35 units is shortly to be placed for another job. The price for this material is $130 a unit, but the supplier allows a bulk discount of f10 a unit, for the entire order, for orders of 50 units and above. (iv) Labour 50 hours of labour will be required for the alterations. Labour is a fixed cost to MM, because members of staff are paid in full the normal t12 an hour whether there is work for them to do or not. 20 hours, of the required 50 hours, can be provided by members of staff who currently have no work to do. Only taking staff off other work can provide the remaining 30 hours. This other work is charged out to customers at $30 an hour. Required: (a) Show, with supporting explanations, the minimum price that MM should charge the customer for the altered machine, such that the shareholders would be no worse off as a result. (b) Explain the distinction between costs and relevant costs. 6 LSE ONDON SCH OF ECONOMICS AND POLITICAL SCIENCE Department of Accounting 2. Granville Ltd - Relevant cost To consolidate the material so far on relevant costs and opportunity costs, work through the following exercise to identify the relevant costs of the decision. Granville Lid is deciding whether or not to proceed with a special order. Use the details below to determine the relevant cost of the order. (a) The contract requires 200 hours of labour at $5 per hour. Employees possessing the necessary skills are currently employed by the company but they are idle at present due to a lull in the company's normal business. (b) Overhead will be absorbed by the contract at a rate of $10 per labour hour, which consists of E7 for fixed overhead and 3 for variable. (c) The contract will require the use of a storage unit for three months. Granville is committed to rent the unit for one year at a rental of $50 per month. The unit is not in use at present. A neighbouring business has recently approached Granville offering to rent the unit from them for $70 per month. (d) Total fixed overheads are not expected to increase as a result of the contract