Question:
Blastoff Inc. manufactures sophisticated products used in the agriculture industry. The company has been approached by a customer who wants to buy 400 identical products at $200 per unit over the next 12 months.
The data in respect of the production of each individual unit is as follows:
1. Direct material requirements
3kg –direct material X1 - see note a)
2kg- direct material X2 -see note b)
10 litres A687 -see note c)
Notes:
a) Direct material X1 is used continually by Blastoff for manufacturing of a number of different products. There are currently 1,00kg in stock at a carrying value of $4.70 per kg. The replacement value of this direct material is $5.00 per kg.
b) There are 1,200 kg of X2 in stock. The original cost of this direct material was $4.30 per kg. As this direct material has not been used in the past two years, it has been written down to $1.50 per kg, the currents crap value. The only other alternative use for X2 is to use it as a substitute for direct material P4 (currently used to manufacture other products). This, however, requires X2 to be further processed at a cost of $1.60 per kg. The current cost of direct material P4 is $3.60 per kg.
c) Direct material A687 currently costs $5 per litre
2. Labour Requirements
Each unit requires 2 hours of skilled labour and 2.5 hours of semi-skilled labour. There is a permanently appointed skilled labourer, who is paid $50 per hour, who has enough spare time available to supply the skilled labour requirements for the contract. An additional semi-skilled labourer will have to be hired to carry out the contract. Skilled labourers can be hired at $45 per hour and semi-skilled labour at $25 per hour.
3. Overheads
Blastoff recovers overheads at a machine hour rate of $25 per machine hour. $7 of this is for variable costs that vary directly with the production of the components and $18 is for fixed overheads. If the contract with the client is accepted, the fixed overhead costs will increase by $3,200 for the period of the contract. There is currently idle capacity available and the production of each unit will require 4 machine hours.
Required: Prepare a calculation that shows whether or not Blastoff should accept the new order.