Question

Wesco Incorporated’s only product is a combination fertilizer/weedkiller called GrowNWeed. GrowNWeed is sold nationwide to retail nurseries and garden stores.

Zwinger Nursery plans to sell a similar fertilizer/weedkiller compound through its regional nursery chain under its own private label. Zwinger does not have manufacturing facilities of its own, so it has asked Wesco (and several other companies) to submit a bid for manufacturing and delivering a 34,000-pound order of the private brand compound to Zwinger. While the chemical composition of the Zwinger compound differs from that of GrowNWeed, the manufacturing processes are very similar.

The Zwinger compound would be produced in 1,000-pound lots. Each lot would require 37 direct labor-hours and the following chemicals:

Chemicals	Quantity in Pounds
AG-5	330
KL-2	290
CW-7	140
DF-6	240

The first three chemicals (AG-5, KL-2, and CW-7) are all used in the production of GrowNWeed. DF-6 was used in another compound that Wesco discontinued several months ago. The supply of DF-6 that Wesco had on hand when the other compound was discontinued was not discarded. Wesco could sell its supply of DF-6 at the prevailing market price less $0.11 per pound selling and handling expenses.

Wesco also has on hand a chemical called BH-3, which was manufactured for use in another product that is no longer produced. BH-3, which cannot be used in GrowNWeed, can be substituted for AG-5 on a one-for-one basis without affecting the quality of the Zwinger compound. The BH-3 in inventory has a salvage value of $490.

Inventory and cost data for the chemicals that can be used to produce the Zwinger compound are shown below:

Raw Material	Pounds in Inventory	Actual Price per Pound When Purchased		Current Market Price per Pound
AG-5	27,000	$	0.78	$	0.88
KL-2	4,200	$	0.36	$	0.41
CW-7	8,300	$	1.30	$	1.50
DF-6	6,660	$	0.54	$	0.46
BH-3	5,900	$	0.70	(Salvage)

The current direct labor wage rate is $14 per hour. The predetermined overhead rate is based on direct labor-hours (DLH). The predetermined overhead rate for the current year, based on a two-shift capacity with no overtime, is as follows:

Variable manufacturing overhead	$	4.10	per DLH
Fixed manufacturing overhead		7.10	per DLH
Combined predetermined overhead rate	$	11.20	per DLH

Wesco’s production manager reports that the present equipment and facilities are adequate to manufacture the Zwinger compound. Therefore, the order would have no effect on total fixed manufacturing overhead costs. However, Wesco is within 310 hours of its two-shift capacity this month. Any additional hours beyond the 310 hours must be done in overtime. If need be, the Zwinger compound could be produced on regular time by shifting a portion of GrowNWeed production to overtime. Wesco’s direct labor wage rate for overtime is $21 per hour. There is no allowance for any overtime premium in the predetermined overhead rate.

Required:

1. Wesco has decided to submit a bid for the 34,000 pound order of Zwinger’s new compound. The order must be delivered by the end of the current month. Zwinger has indicated that this is a one-time order that will not be repeated. Calculate the lowest price that Wesco could bid for the order and still exactly cover its incremental manufacturing costs.

2. Refer to the original data. Assume that Zwinger Nursery plans to place regular orders for 34,000-pound lots of the new compound. Wesco expects the demand for GrowNWeed to remain strong. Therefore, the recurring orders from Zwinger would put Wesco over its two-shift capacity. However, production could be scheduled so that 60% of each Zwinger order could be completed during regular hours. As another option, some GrowNWeed production could be shifted temporarily to overtime so that the Zwinger orders could be produced on regular time. Current market prices are the best available estimates of future market prices.

Wesco’s standard markup policy for new products is 40% of the full manufacturing cost, including fixed manufacturing overhead. Calculate the price that Wesco, Inc., would quote Zwinger Nursery for each 34,000 pound lot of the new compound, assuming that it is to be treated as a new product and this pricing policy is followed.

Answer 1

Calculation of the Lowest Price that Wesco could bid for the order without reducing its Net Operating Income:
Particular	Amount	Amount
Direct materials:
Material AG-5 ( Required Unit: 34 Lot x 330 Pound =11220 Pound)
Relevant cost of BH-3 (5900 Pound) used as a subsitute of AG-5	$490.00
Purchase AG-5: (11220-5900 Pound)@ $0.88	$4,681.60
Material KL-2 Purchase ( 34 Lot x 290 Pound) x $0.41	$4,042.60
CW-7: Purchase ( 34 Lot x 140 Pound) x $1.50	$7,140.00
Material DF-6 ( Required Unit: 34 Lot x 240 Pound =8160 Pound)
Relevant cost of DF-3 (6660 Pound)= ($0.46-$0.11)*6660	$2,331.00
Purchase DF-3 : (8160-6660 Pound)@ $0.46	$690.00
Total direct materials cost		$19,375.20
Direct labor: 37 DLHs per lot * 34 lots = 1,258DLHs. Because only 310 hours can be scheduled during regular time this month, overtime would have to be used for the remaining 948 hours.
310 DLHs × $14.00 per DLH	$4,340.00
948 DLHs × $21.00 per DLH	$19,908.00
Total direct labor cost		$24,248.00
Overhead: This special order will not increase fixed overhead costs. Therefore, only the variable overhead is relevant.
1258 DLHs × $4.10 per DLH		$5,157.80
Total relevant cost of the special order		$48,781.00
2) Calculation of the price for recurring orders of 34,000 pounds (34 lots) using the company’s rule of marking up its full manufacturing cost:
Particular	Amount	Amount
Direct materials: Because the initial order will exhaust existing inventories of BH-3 and DF-6 and new supplies would have to be purchased, all raw materials should be charged at their expected future cost, which is the current market price.
AG-5: 11,220 pounds × $0.88 per pound	$9,873.60
KL-2: 9860 pounds × $0.41 per pound	$4,042.60
CW-7: 4760 pounds × $1.50 per pound	$7,140.00
DF-6: 8160 pounds × $0.46 per pound	$3,753.60
Total direct materials cost		$24,809.80
Direct labor: 60% (i.e., 754.80 DLHs) of the production of a batch can be done on regular time; but the remaining production (i.e., 503.20 DLHs) must be done on overtime.
Regular time 754.80 DLHs × $14.00 per DLH	$10,567.20
Overtime premium 503.20 DLHs × $21.00 per DLH	$10,567.20
Total direct labor cost		$21,134.40
Overhead: The full manufacturing cost includes both fixed and variable manufacturing overhead.
Manufacturing overhead applied: 1258 DLHs × $11.20 per DLH		$14,089.60
Full manufacturing cost		$60,033.80
Markup (40% × $60033.80)		$24,013.52
Selling price (full manufacturing cost plus markup)		$84,047.32