KK Enterprises has received an enquiry from a customer for the supply of 500 units of a new product, Product M22. Negotiations on the final price to charge the customer are in progress and the sales manager has asked you to supply relevant cost information.
The following information is available:
(1) Each unit of Product M22 requires the following raw materials:
| Raw material type |
Quantity |
| X |
4 kg |
| Y |
6 kg |
(2) The company has 5,000 kg of material X currently in stock. This was purchased last year at a cost of GH¢7 per kg. If not used to make Product M22, this inventory of X could either be sold for GH¢7.50 per kg or converted at a cost of GH¢1.50 per kg, so that it could be used as a substitute for another raw material, material Z, which the company requires for other production. The current purchase price per kilogram for materials is GH¢9.50 for material Z and GH¢8.25 per kg for material X.
(3) There are 10,000 kilograms of raw material Y in inventory, valued on a FIFO basis at a total cost of GH¢142,750. Of this current inventory, 3,000 kilograms were purchased six months ago at a cost of GH¢13.75 per kg. The rest of the inventory was purchased last month. Material Y is used regularly in normal production work. Since the last purchase of material Y a month ago, the company has been advised by the supplier that the price per kilogram has been increased by 4%.
(4) Each unit of Product M22 requires the following number of labour hours in its manufacture:
| Type of labour |
Hours |
| Skilled |
5 |
| Unskilled |
3 |
Skilled labour is paid GH¢8 per hour and unskilled labour GH¢6 per hour.
(5) There is a shortage of skilled labour, so that if production of M22 goes ahead it will be necessary to transfer skilled workers from other work to undertake it. The other work on which skilled workers are engaged at present is the manufacture of Product M16. The selling price and variable cost information for M16 are as follows:
|
GH¢ per unit |
| Selling price |
100 |
| Less: variable costs of production |
|
| Skilled labour (3 hours) |
24 |
| Other variable costs |
31 |
|
55 |
| Contribution |
45 |
(6) The company has a surplus of unskilled workers who are paid a fixed wage for a 37-hour week. It is estimated that there are 900 hours of unused unskilled labour time available during the period of the contract. The balance of the unskilled labour requirements could be met by working overtime, which is paid at time and a half.
(7) The company absorbs production overheads by a machine hour rate. This absorption rate is GH¢22.50 per hour, of which GH¢8.75 is for variable overheads and the balance is for fixed overheads. If production of Product M22 is undertaken, it is estimated that an extra GH¢4,000 will be spent on fixed costs. Spare machining capacity is available and each unit of M22 will require two hours of machining time in its manufacture using the existing equipment. In addition, special finishing machines will be required for two weeks to complete the M22. These machines will be hired at a cost of GH¢2,650 per week, and there will be no overhead costs associated with their use.
(8) Cash spending of GH¢3,250 has been incurred already on development work for the production of M22. It is estimated that before production of the M22 begins, another GH¢1,750 will have to be spent on development, making a total development cost of GH¢5,000.
Required:
Calculate the minimum price that the company should be prepared to accept for the 500 units of Product M22. Explain briefly but clearly how each figure in the minimum price calculation has been obtained.
(Note: The minimum price is the price that equals the total relevant costs of producing the items. Any price in excess of the minimum price will add to total profit).
