Problem 6-4

Brennen Co. produces a mint syrup used by gum and candy companies. Recently, the company has had excess capacity due to a foreign supplier entering its market. Brennen is currently bidding on a potential order from Quality Candy for 5,000 cases of syrup. The estimated cost of each case is $23, as follows:

Direct material

$ 9

Direct labor

$ 5

Overhead

$ 9

Total

$ 23

The predetermined overhead rate is $1.80 per direct labor dollar.This was estimated by dividing estimated annual overhead ($1,080,000) by estimated annual direct labor ($600,000). The $1,080,000 of overhead is composed of $270,000 of variable costs and $810,000 of fixed costs.The largest fixed cost relates to depreciation of plant and equipment.

Required

a.

With respect to overhead, what is the opportunity cost of producing a case of syrup?

b.

Suppose Brennen can win the Quality Candy business by bidding a price of $19 per case (but no higher price will result in a winning bid). Should Brennen bid $19?

c.

Discuss how an allocation of overhead based on opportunity cost would facilitate an appropriate bidding decision.