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.