
Answers
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Undertaking the contract will add $1,400 to total profit. On a purely financial basis,
this means that the contract is worth undertaking. However, management might
take the view that a higher profit margin is desirable, and the suggested price of
$145 per component might be negotiable.
20 Product B22
Workings for relevant costs
Material X
The company has enough kilograms of material X in inventory for the contract.
When it is used, the inventory of material X will not be replaced. The relevant cost
of the material is therefore its opportunity cost, not its replacement cost. The
opportunity cost is the higher of its current sale value ($7.50 per kg) or the net
saving obtained if it is used as a substitute for material Z ($9.50 – $1.50 = $8 per kg).
The relevant cost of material X is therefore $8 per kg.
Material Y
Material Y is in regular use, so its relevant cost is its current replacement cost.
kg
$
Total inventory 10,000
142,750
Purchased six months ago 3,000
(× $13.75)
41,250
Purchased last month 7,000
101,500
Purchase price last month = $101,500/7,000 kg = $14.50 per kg.
Current purchase price = 4% higher = $14.50 × 1.04 = $15.08.
Skilled labour
Skilled labour is in short supply. If it is used to make product B22, workers will
have to be taken off other work. The relevant cost of skilled labour is the wages for
the skilled workers for the time spent on B22, plus the lost contribution (net of
skilled labour cost) from not being able to make units of product B16.
Opportunity cost of skilled labour
Skilled labour cost per unit of Product B16 = $24
Number of hours per unit = 3 hours
Contribution per unit of B16 = $45
Contribution per skilled labour hour from B16 = $15
Opportunity cost of skilled labour if it is used to make B22 = (500 × 5) × $15 =
$37,500
Unskilled labour
900 unskilled labour will be available at no incremental cost to the company (as it is
already being paid and is not fully employed). There is no relevant cost for these
hours. The additional 600 hours required will involve extra wage payments,
including overtime payments. The relevant cost of these 600 hours is $6 per hour ×
150% = $9 per hour, including the overtime premium.