Question 3 London Ltd 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 manufacturers has offered a contract to London Ltd for the supply, over the next 12 months, of 800 identical components. The data relating to the production of components is as follows: Material requirements per component 6 kg material MM1 (see note 1 below) 4 kg material PP2 (see note 2 below) 2 parts no. 687 (see note 3 below)

Note 1: material MM1 is in continuous use by the company. 2,000 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: 4,400 kg of material PP2 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 substitute for material PP4 (in current use), but this would involve further processing costs of 1.60 per kg. The current cost of material PP4 is 3.60 per kg. Note 3: It is estimated that part no. 687 could be bought for 50 each. See Next Page 8 Labour requirements Each component would require 10 hours of skilled labour. Employees possessing the necessary skills are available and are currently paid 12 per hour.

A replacement would, however, have to be obtained at a rate of 13 per hour for the work which would otherwise be done by the skilled employees. Each component would require 10 hours of semi-skilled labour. The current rate for semi-skilled work is 10 per hour and additional employees could be appointed for this work. Overheads If this contract is undertaken, it is estimated that fixed costs will increase for the duration of the contract by 3,200. A price of 420 per component has been suggested by a large company which makes aircraft. London Ltd considers charging the same price.

Required: (a) State whether or not the contract should be accepted and support your conclusion with appropriate figures for presentation to management. (10 marks)

(b) Comment on the main factors which management ought to consider, and which may influence their decision. (7 marks) (Total 17 marks)