Didcot is small company that specialises in producing virtual reality (VR) machines for large international entertainment companies. One of these has offered Didcot a contract to produce and deliver 1000 identical VR machines over a 26-week period starting on 1 June 2004.

Each machine requires the following materials:

· 2 square metres of Yalloy: Yalloy is in continuous use by the company and 500 square metres are currently in stock at a book value of £80 per square metre. Future purchases will cost £90 per square metre.

· 1 translucent fitment: 1500 are in stock at a book value of £10 each. However, this type of fitment will have no other use if not used on this contract, although they may be sold for scrap at £2 each. It is possible to purchase a new version of the fitment at £20 per fitment, although the type in stock is adequate for the contract.

· 2 yardarm controllers: there are none in stock. The current purchase price is £50 per controller.

· 1 piezo control: these will be purchased at £25 each and are specific to VR machines in the contract.

The following mixture of labour is required:

· Skilled: each VR machine will require 3 hours of skilled labour. Skilled labour is currently paid £4.80 per hour and will be fully employed on other work during the next 26 weeks. In order to fulfil the contract a skilled worker will be taken off other work which will be undertaken by a temporary replacement provided by a local agency at £6 per hour.

· Semi-skilled: each machine will require 4 hours of semi-skilled labour. The current rate for semi-skilled labour is £3.50 per hour and sufficient temporary workers can be recuited for this work.

In the case of both skilled and semi-skilled employees, national insurance adds a further 12% to the cost of employment. This is not payable by Didcot in the case of agency workers.

Supervision of the work will be carried out by a senior manager who is currently paid £25,000 per year (with superannuation and national insurance adding a further 20% to the costs of employment). In order to free her time to undertake this work, an agency will provide cover at a cost of £500 per week.

Didcot absorbs production overhead by a machine rate that is currently £40 per hour. Of this, £15 is variable and £25 is fixed. Each VR machine will require 2 machine hours. Additionally, fixed overheads directly attributable to the production of VRs are likely to increase by £15,000 over the period of the contract.

The costs of negotiating and drawing up the contract to supply 1000 VR machines have amounted to £800.

A price of £520 per machine has been agreed with the entertainment company. The entertainment company has stipulated within the contract that it will pay only £250 per machine for any that are delivered up to four weeks late. Machines delivered more than four weeks late will be delivered free of charge.

(a) Prepare a statement of the relevant costs of the contract and state whether or not the contract should be undertaken by Didcot. Provide notes to indicate why you have selected some costs and rejected others.

(b) Comment on three significant factors that management needs to consider before finally agreeing to take the contract.