Decision on which of two mutually exclusive contracts to accept

A company in the civil engineering industry with headquarters located 22 miles from London undertakes contracts anywhere in the United Kingdom.

The company has had its tender for a job in north-east England accepted at £288 000 and work is due to begin in March. However, the company has also been asked to undertake a contract on the south coast of England. The price offered for this contract is £352 000. Both of the contracts cannot be taken simultaneously because of constraints on staff site management personnel and on plant available. An escape clause enables the company to withdraw from the contract in the north-east, provided notice is given before the end of November and an agreed penalty of £28 000 is paid.

The following estimates have been submitted by the company’s quantity surveyor:

Cost estimates

North-east

South coast

(£)

(£)

Materials:

In stock at original cost, Material X

21600

In stock at original cost, Material Y

24800

Firm orders placed at original cost, Material X

30400

Not yet ordered — current cost, Material X

60000

Not yet ordered — current cost, Material Z

71200

Labour — hired locally

86000

110000

Site management

34000

34000

Staff accommodation and travel for site management

6800

5600

Plant on site —depreciation

9600

12800

Interest on capital, 8%

5120

6400

Total local contract costs

253520

264800

Headquarters costs allocated at rate of 5% on total contract costs

12676

13240

266196

278040

Contract price

288000

352000

Estimated profit

21804

73960

Notes.

(a) to present comparative statements to show the net benefit to the company of undertaking the more advantageous of the two contracts;

(b) to explain the reasoning behind the inclusion in (or omission from) your comparative financial statements, of each item given in the cost estimates and the notes relating thereto.