Wesco Incorporated’s only product is a combination fertilizer/weedkiller called
ID: 2601825 • Letter: W
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 39 direct labor-hours and the following chemicals:
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 $0.09 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 $570.
Inventory and cost data for the chemicals that can be used to produce the Zwinger compound are shown below:
The current direct labor wage rate is $10 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:
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 440 hours of its two-shift capacity this month. Any additional hours beyond the 440 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 $15 per hour. There is no allowance for any overtime premium in the predetermined overhead rate.
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 without reducing its net operating income.
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. Hint: Calculate the price considering the possibility of this order being regular.
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 39 direct labor-hours and the following chemicals:
Explanation / Answer
1. The lowest price Wesco could bid for the one-time special order of 34,000 pounds (31 lots) without losing money would be $46,684.20, as shown below:
Direct materials:
AG-5: 360 pounds per lot × 34 lots = 12,240 pounds.
Substitute BH-3 on a one-for-one basis to its total of 5,500 pounds. If BH-3 is not used in this order, it will be salvaged
for $570. Therefore, the relevant cost is............................ $ 570
The remaining 6,740 pounds would be AG-5 at a cost of
$0.83 per pound.............................................................. 5,594.20
KL-2: 250 pounds per lot × 34 lots = 8,500 pounds at $0.57
per pound ....................................................................... 4,845
CW-7: 160 pounds per lot × 34 lots = 5,440 pounds at
$1.52 per pound.............................................................. 8,268.80
DF-6: 230 pounds per lot × 34 lots = 7,820 pounds. Use 6,320 pounds in inventory at $0.53 per pound ($0.62 market price – $0.09 handling charge), and purchase the
remaining 1500 pounds at $0.62 per pound ........................ 4,279.60
Total direct materials cost ................................................... 23,557.60
Direct labor: 39 DLHs per lot × 34 lots = 1326 DLHs. Because only 440 hours can be scheduled during regular time this month, overtime would have to be used for the remaining 886 hours.
440 DLHs × $10.00 per DLH ...............................................
4,400
886 DLHs × $15.00 per DLH ...............................................
13,290
Total direct labor cost .........................................................
17,690
Overhead: This special order will not increase fixed overhead costs.
Therefore, only the variable overhead is relevant.
1326 DLHs × $4.10 per DLH................................................. 5,436.60
Total relevant cost of the special order................................... $46,684.20
2. In this part, we calculate the price for recurring orders of 34,000 pounds (34 lots) using the company’s rule of marking up its full manufacturing cost. This is not the best pricing policy to follow, but is a common practice in business.
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: 12,240 pounds × $0.83 per pound ............................
$10,159.20
KL-2: 8,500 pounds × $0.57 per pound .............................
4,845
CW-7: 5,440 pounds × $1.52 per pound............................
8,268.80
DF-6: 7,820 pounds × $0.62 per pound.............................
4,848.40
Total direct materials cost ................................................
28,121.40
Direct labor: 60% (i.e., 796 DLHs) of the production of a batch can be done on regular time; but the remaining production (i.e., 530 DLHs) must be done on overtime.
Regular time 796 DLHs × $10.00 per DLH .........................
7,960
Overtime premium 530 DLHs × $15.00 per DLH ..................
7,950
Total direct labor cost .......................................................
15,910
Overhead: The full manufacturing cost includes both fixed and variable manufacturing overhead.
Manufacturing overhead applied:
1326 DLHs × $10.90 per DLH ..........................................
14,453.40
Full manufacturing cost ......................................................
58,485
Markup (40% × $58,485) ...................................................
23,394
Selling price (full manufacturing cost plus markup)...............
$81,879
440 DLHs × $10.00 per DLH ...............................................
4,400
886 DLHs × $15.00 per DLH ...............................................
13,290
Total direct labor cost .........................................................
17,690
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