Wright is a builder. His business will have spare capacity over the coming six months and he has been investigating two projects.
Project A
Wright is tendering for a school extension contract. Normally he prices a contract by adding 100% to direct costs, to cover overheads and profit. He calculates direct costs as the actual cost of materials valued on a first-in-first-out basis, plus the estimated wages of direct labour. But for this contract he has prepared more detailed information.
Four types of material will be needed:
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Quantity (units): |
Price per unit: |
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Purchase |
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price of |
Current |
Current |
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|
Needed for |
Already |
units |
purchase |
resale |
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|
Material |
contract |
in stock |
in stock |
price |
price |
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(£) |
(£) |
(£) |
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|
z |
1100 |
100 |
7.00 |
10.00 |
8.00 |
|
Y |
150 |
200 |
40.00 |
44.00 |
38.00 |
|
X |
600 |
300 |
35.00 |
33.00 |
25.00 |
|
w |
200 |
400 |
20.00 |
21.00 |
10.00 |
Z and Y are in regular use. Neither X nor W is currently used; X has no foreseeable use in the business, but We could be used on other jobs in place of material currently costing £16 per unit.
The contract will last for six months and requires two craftsmen, whose basic annual wage cost is £16 000 each. To complete the contract in time it will also be necessary to pay them a bonus of £700 each. Without the contract they would be retained at their normal pay rates, doing work which will otherwise be done by temporary workers engaged for the contract period at a total cost of £11 800.
Three casual labourers would also be employed specifically for the, contract at a cost of £4000 each.
The contract will require two types of equipment: general-purpose equipment already owned by Wright, which will be retained at the end of the contract, and specialized equipment to be purchased second-hand, which will be sold at the end of the contract.
The general-purpose equipment cost £21 000 two years ago and is being depreciated on a straight-line basis over a seven-year life (with assumed zero scrap value). Equivalent new equipment can be purchased currently for £49 000. Second-hand prices for comparable general-purpose equipment, and those for the relevant specialized equipment, are shown below.
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General-purpose |
Specialized |
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|
equipment |
equipment |
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|
Purchase |
Resale |
Purchase |
Resale |
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|
price |
price |
price |
price |
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|
(£) |
(£) |
(£) |
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|
Current |
20 000 |
17 200 |
9000 |
7400 |
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After 6 months: |
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|
if used for |
15 000 |
12 600 |
7000 |
5800 |
|
6 months if not used |
19 000 |
16 400 |
8000 |
6500 |
The contract will require the use of a yard on which Wright has a four-year lease at a fixed rental of £2000 per year. If Wright does not get the contract the yard will probably remain empty. The contract will also incur administrative expenses estimated at £5000.
Project B
If Wright does not get the contract he will buy a building plot for £20 000 and build a house. Building costs will depend on weather conditions:
|
Weather condition |
A |
B |
C |
|
Probability |
0.4 |
0.4 |
0.2 |
|
Building costs |
£60000 |
£80 000 |
£95 000 |
|
(excluding land) |