Sydney Steelworks is engaged in a costing dispute with PublicWorks Canada. The company has a cost-plus contract to supplyspecialty steel that has no evident market price. The contractcalls for Sydney to be reimbursed for its manufacturing costs plus35%. An independent shipper hauls the steel from the Sydney plantto the various construction sites.

The variable cost of manufacturing the steel is $200 per ton,which is not in dispute. The issue concerns the allocation of fixedmanufacturing costs to this product. The current annual fixedmanufacturing cost at Sydney is $300,000,000. The plant isoperating at 40% of practical capacity, which is measured in tons.Sydney computes the fixed manufacturing overhead rate by dividingthe fixed manufacturing cost by the planned level of operations.This has resulted in charging this contract a rate of $120 per tonfor fixed manufacturing costs.

Cost analysts at Public Works have objected, citing industryevidence that, on average, steel companies are using 70% of theirpractical capacity.

Required:

1. Compute the contract price per ton using Sydney’sapproach.
2. Compute the contract price per ton if Sydney uses averageindustry capacity to compute the fixed manufacturing overheadrate.
3. If you were hired to arbitrate this dispute, how would youresolve it?
4. If you were a Public Works Canada auditor, what would yourecommend based on this experience?