Chapter 11, Problem 11.38P

Opportunity costs and relevant costs. Jason Wu operates Exclusive Limousines, a fleet of 10 limousines used for weddings, proms, and business events in Washington, D.C. Wu charges customers a flat fee of $250 per car taken on contract plus an hourly fee of $80. His income statement for May follows:

Revenue (200 contracts × $250) + (1,250 hours × $80)	$150,000
Operating expenses:
Driver wages and benefits ($35 per hour × 1,250 hours)	43,750
Depreciation on limousines	19,000
Fuel costs ($12.80 per hour × 1,250 hours)	16,000
Maintenance	18,400
Liability and casualty insurance	2,500
Advertising	10,500
Administrative expenses	24,200
Total expenses	134,350
Operating income	$ 15,650

All expenses are fixed, with the exception of driver wages and benefits and fuel costs, which are both variable per hour. During May, the company’s limousines were fully booked. In June, Wu expects that Exclusive Limousines will be operating near capacity. Shelly Worthington, a prominent Washington socialite, has asked Wu to bid on a large charity event she is hosting in late June. The limousine company she had hired has canceled at the last minute, and she needs the service of five limousines for four hours each. She will only hire Exclusive Limousines if they take the entire job. Wu checks his schedule and finds that he only has three limousines available that day.

1. 1. If Wu accepts the contract with Worthington, he would either have to (a) cancel two prom contracts each for one car for six hours or (b) cancel one business event for three cars contracted for two hours each. What are the relevant opportunity costs of accepting the Worthington contract in each case? Which contract should he cancel?

Required

1. 2. Wu would like to win the bid on the Worthington job because of the potential for lucrative future business. Assume that Wu cancels the contract in requirement 1 with the lowest opportunity cost, and assume that the three currently available cars would go unrented if the company does not win the bid. What is the lowest amount he should bid on the Worthington job?
2. 3. Another limousine company has offered to rent Exclusive Limousines two additional cars for $300 each per day. Wu would still need to pay for fuel and driver wages on these cars for the Worthington job. Should Wu rent the two cars to avoid canceling either of the other two contracts?