XYZ Ltd is engaged in a costing dispute with Public Works Canada. The company has a cost-plus contract to supply specialty steel that has no evident market price. The contract calls for XYZ Ltd to be reimbursed for its manufacturing costs plus 35%. An independent shipper hauls the steel from the XYZ Ltd plant to the various construction sites.

The variable cost of manufacturing the steel is $200 per ton, which is not in dispute. The issue concerns the allocation of fixed manufacturing costs to this product. The current annual fixed manufacturing cost at XYZ Ltd is $300,000,000. The plant is operating at 40% of practical capacity, which is measured in tons. XYZ Ltd computes the fixed manufacturing overhead rate by dividing the fixed manufacturing cost by the planned level of operations. This has resulted in charging this contract a rate of $120 per ton for fixed manufacturing costs.

Cost analysts at Public Works have objected, citing industry evidence that, on average, steel companies are using 70% of their practical capacity.

Required:

1)Compute the contract price per ton using XYZ Ltd's approach.

2)Compute the contract price per ton if XYZ Ltd uses average industry capacity to compute the fixed manufacturing overhead rate.

3)If you were hired to arbitrate this dispute, how would you resolve it?

If you were a Public Works Canada auditor, what would you recommend based on this experience?