Case 12-31 Integrative Case: Relevant Costs; Pricing [LO12-1,LO12-4]

Wesco Incorporated’s only product is a combinationfertilizer/weedkiller called GrowNWeed. GrowNWeed is soldnationwide to retail nurseries and garden stores.

Zwinger Nursery plans to sell a similar fertilizer/weedkillercompound through its regional nursery chain under its own privatelabel. Zwinger does not have manufacturing facilities of its own,so it has asked Wesco (and several other companies) to submit a bidfor manufacturing and delivering a 20,000-pound order of theprivate brand compound to Zwinger. While the chemical compositionof the Zwinger compound differs from that of GrowNWeed, themanufacturing processes are very similar.

The Zwinger compound would be produced in 1,000-pound lots. Eachlot would require 25 direct labor-hours and the followingchemicals:

Chemicals	Quantity in Pounds
AG-5	300
KL-2	200
CW-7	150
DF-6	175

The first three chemicals (AG-5, KL-2, and CW-7) are all used inthe production of GrowNWeed. DF-6 was used in another compound thatWesco discontinued several months ago. The supply of DF-6 thatWesco had on hand when the other compound was discontinued was notdiscarded. Wesco could sell its supply of DF-6 at the prevailingmarket price less $0.10 per pound selling and handlingexpenses.

Wesco also has on hand a chemical called BH-3, which wasmanufactured for use in another product that is no longer produced.BH-3, which cannot be used in GrowNWeed, can be substituted forAG-5 on a one-for-one basis without affecting the quality of theZwinger compound. The BH-3 in inventory has a salvage value of$600.

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

Raw Material	Pounds in Inventory	Actual Price per Pound When Purchased		Current Market Price per Pound
AG-5	18,000	$	1.15	$	1.20
KL-2	6,000	$	1.10	$	1.05
CW-7	7,000	$	1.35	$	1.35
DF-6	3,000	$	0.80	$	0.70
BH-3	3,500	$	0.90	(Salvage)

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

Variable manufacturing overhead	$	3.00	per DLH
Fixed manufacturing overhead		10.50	per DLH
Combined predetermined overhead rate	$	13.50	per DLH

Wesco’s production manager reports that the present equipmentand facilities are adequate to manufacture the Zwinger compound.Therefore, the order would have no effect on total fixedmanufacturing overhead costs. However, Wesco is within 400 hours ofits two-shift capacity this month. Any additional hours beyond the400 hours must be done in overtime. If need be, the Zwingercompound could be produced on regular time by shifting a portion ofGrowNWeed production to overtime. Wesco’s direct labor wage ratefor overtime is $21 per hour. There is no allowance for anyovertime premium in the predetermined overhead rate.

Required:

1. Wesco has decided to submit a bid for the 20,000 pound orderof Zwinger’s new compound. The order must be delivered by the endof the current month. Zwinger has indicated that this is a one-timeorder that will not be repeated. Calculate the lowest price thatWesco could bid for the order and still exactly cover itsincremental manufacturing costs.

2. Refer to the original data. Assume that Zwinger Nursery plansto place regular orders for 20,000-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 itstwo-shift capacity. However, production could be scheduled so that90% of each Zwinger order could be completed during regular hours.As another option, some GrowNWeed production could be shiftedtemporarily to overtime so that the Zwinger orders could beproduced on regular time. Current market prices are the bestavailable estimates of future market prices.

Wesco’s standard markup policy for new products is 40% of thefull manufacturing cost, including fixed manufacturing overhead.Calculate the price that Wesco, Inc., would quote Zwinger Nurseryfor each 20,000 pound lot of the new compound, assuming that it isto be treated as a new product and this pricing policy isfollowed.