Car Components Inc. ('CCI') manufactures and sells brake and suspension components used in the car industry. Some components are sold through garages and motor factors to the public but the bulk are sold direct to car manufacturers. In particular, CCI has provided components for many years to Victor Motors, its largest client, who takes 40% of CCI's output. Pricing has always been based on full production cost plus25%.

Intense competition within the car industry has seen CCI's market share decline and last year it only operated at 70% capacity. CCI's clients have not been immune to industry pressure either and recently Victor Motors was bought out by a multinational manufacturer. The new owners have decided that the component contract would now be put out to tender each year and have made it clear that price, while not the only consideration, would be a major factor in deciding on the preferred supplier.

The management accountant of CCI has put together the following cost schedule for the CCI contract for the next year:

Note 1: There is currently $500,000 of materials inventory. If not used on Victor Motor components this would be sold to a third party, but incur a net loss (after delivery charges are taken into account) of $100,000.

Note 2: Victor Motors components are highly specialized. If the contract was lost, then all of the current staff making Victor components would have to be made redundant. Redundancy costs re-estimated to be $500,000 now or $600,000 in one year's time.

Note 3: Fixed overheads consist of unavoidable company-wide costs and depreciation. If the contract is lost then machinery would be sold for $600,000 now or $450,000 in one year.

Required:

Calculate the incremental cost of completing the Victor Motors contract for one more year and suggest a minimum tender price.

Answer rating: 100% (QA)

To calculate the incremental cost of completing the Victor Motors contract for one more year we need ... View the full answer