Question

Trent Controls Ltd is an electronic engineering business that specialises in the production of electronic equipment for security forces throughout the world. Recently it has received a request to produce 10 x VVD units for a foreign government. The VVD was developed some time ago by the business at a total research and development cost of £220,000. Up to this point there has been no interest shown in the equipment and no units have been produced. The present order seems likely to represent the total sales for the VVD. The product specification for each unit is set out below: Materials Component A - 3 per unit Component B - 1 per unit Component C - 2 per unit Component A is normally held in inventory as it is a component that is widely used for other products within Trent Control’s product range. There are 15 components currently held in inventory. These cost £1,800 each. The sole supplier of this component has announced an immediate price rise of 5% for any future purchases. Component B is no longer used for any other of Trent Control’s products. There are six components in inventory costing £2,000 each. It is now possible to buy additional components at a cost of £2,200 each; however, the supplier insists on a minimum order quantity of six components. Any components that are not used on this contract will be disposed of at a total cost to Trent Controls of £250, irrespective of the quantity to be disposed. Component C is used by the business throughout its product range. At present there is none in inventory. However, an order for 20 components for use in another contract is about to be placed. The supplier normally charges £1,600 per component but for orders above 30 components a discount of 10% is available on the total order price. Additional materials costing £2,800 in total will have to be bought if the contract is undertaken. Labour Assembly time is estimated at 10 hours for each VVD unit. The workforce required to assemble the product is paid £7.00 an hour and is in great demand. If the order is accepted the necessary labour will have to be transferred from existing work and, as a result, other orders will be lost. It is estimated that for each hour that labour is transferred to this product £50 of sales revenue will be lost but that savings of £15 an hour in materials relating to lost sales will be made. Inspection time is estimated at five hours for each VVD unit. Inspection labour can be provided by paying existing employees overtime which is paid at a 33.334% premium over the standard rate of £6.00 an hour. Overheads The business normally includes a mark-up of 30% to cover overheads. This contract is not expected to give rise to any increases in overheads.

Required: Prepare an estimate of the absolute minimum price that Trent Controls Ltd could undertake the contract for, in order that the business would be no worse off as a result of taking the order. Your answer should clearly explain your treatment of all of the information given in the question.

Answer 1

To produce 10 nos. VVD
1.Material costs
a.Component A
Total requirement =3*10=30 nos.
Inventory in-hand	15*1800=	27000
Bal.to be purchased	15*1800*1.05=	28350
Total cost			55350
b.Component B
Total requirement =1*10=10 nos.
Inventory in-hand	6*2000=	12000
Bal.(in 6s)to be purchased	6*2200=	13200
Less: Disposal value of 2 unit		-250
Total cost			24950
c.Component C
Total requirement =2*10=20 nos.
Cost of new order	20*1600*(1-10%)=	28800	28800
d.Additional materials			2800
2. Labor
a. Assembly
Total hrs. reqd. 10 hrs.*10=100 hrs.
Cost of labor	100*7=	700
Add: Opportunity cost of lost sales(net)	(50-15)*100=	3500
Total cost			4200
b. Inspection
Total hrs. reqd. 5 hrs.*10=50 hrs.
Cost of labor	50*6*1/3=		100
3. Overheads			0
Total minimum cost of the contract			116200
Mark up of 30%*116200			34860
Absolute minimum price			151060
Price per VVD(151060/10)			15106