Jesmond Ltd, a small business that specialises in manufacturing electronic-control equipment, has just received an enquiry from a potential customer for eight identical robotic units. These would be made using the companys labour force and factory capacity. The product specification prepared by the estimating department shows the following:

Material and labour requirements for each robotic unit:

Component X - 3 per unit

Component Y - 1 per unit

Component Z - 5 per unit

Assembly labour - 25 hours per unit (but see below)

Inspection labour - 6 hours per unit

As part of the costing exercise, the business has collected the following information:

Component X: This item is normally held by the business as it is in constant demand. There are 10 units currently held, which were bought for 160 a unit. The sole supplier of Component X has announced a price rise of 25%, effective immediately, for any further supplies. Jesmond has not yet paid for the items currently held.

Component Y: 25 units are currently held. This component is not normally used by Jesmond, but the units currently held are because of a cancelled order following the bankruptcy of a customer. The units originally cost the business 6,500 in total, although Jesmond has recouped 2,750 from the liquidator of the bankrupt business. As Jesmond can see no use for these units (apart from the possible use of some of them in the order now being considered), the finance director proposes to scrap all 25 units (zero proceeds).

Component Z. This is in regular use by Jesmond. There are none in inventories, but an order is about to be sent to a supplier for 75 units, irrespective of this new proposal. The supplier charges 23 a unit on small orders but will reduce the price to 18 a unit for all units on any order over 110 units.

Other items. These are expected to cost 375 in total.

Assembly labour is currently in short supply in the area and is paid at 12 an hour. If the order is accepted, all necessary labour will have to be transferred from existing work. As a result, other orders will be lost. It is estimated that for each hour transferred to this contract, 41 will be lost (calculated as lost sales revenue 72, less materials 17 and labour 14). The production director suggests that owing to a learning process, the time taken to make each unit will reduce, from 23 hours to make the first one, by one hour a unit made. (That is, it will take 23 hours to make the first one, 22 hours to make the second, 21 hours to make the third one and so on.)

Inspection labour can be provided by paying existing personnel overtime which is at a premium of 40 per cent over the standard rate of 16 an hour.

You are Jenny Joshua, a recently qualified Management Accountant, and you have been asked by the board of directors of Jesmond Ltd to advise them with planning for the future production of the robotic units.

Required:

The board of directors of Jesmond Ltd would like you to advise them on the following items and have asked that you present your findings in an email to the Chief Financial Officer.

a) The directors would like to be clear on the distinction between sunk cost and opportunity cost.

Distinguish between both costs and provide one example from the above scenario for each of the costs.

(5 marks)

b) The directors believe that the company will be able to meet the demand from the potential customer. They are, however, unsure as to the minimum price to quote for the order.

Using the data provided, prepare an estimate of the minimum price that you would recommend Jesmond Ltd to charge for the proposed contract such that it would be neither better nor worse off as a result.

(15 marks)

c) One of the directors has argued that the decision to produce the robotic units should not depend entirely on financial considerations.

Identify any other factors that you would consider before fixing the final price.

(5 marks)

(Total 25 Marks)