Relevant Cash Flows for DCF Relevant Costs (example 1)

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1. says

sir
can you please explain how we are saving on materials? i did not understand the logic

• says

The materials are toxic and if we do not use them in the contract we will have to pay to dispose of them.

If we use them on the contract then we will not dispose of them and therefore will save the cost of disposing of them.

• says

the materials of 40000 included in the prime cost is the same as the toxic materials of 40000?

• says

There are no materials of \$40,000 in the prime cost (and they are not the same materials!).

You did not say which materials you were asking about – the only materials needed for the contract are those under the heading ‘materials’ and they are what my answer here was referring to.

It seems you are actually asking about the relevant cost of the labour used. Because they are being moved from other work there is the opportunity cost of \$90,000 of moving them. You can get the same answer two ways – whichever is more obvious to you – either it is the cost of labour (40,000) plus the lost contribution (150,000 – 100,000 = 50000).
Alternatively, if you find it more obvious, if we stop the other production then we lose the sales (150,000). However if we are not producing the other product we do not need to spend the money on the materials for the other product (60,000 (100,000 – 40000)). So the net cost is 150,000 – 60,000 = 90,000.

• says

thank you sir for clearing my doubt ????

2. says

Hi John. Shouldn’t we discount the redundancy cost that will be incurred in a years time rather than subtract it from the redundancy cost if we were to discontinue the project?

• says

That would be fine, except that this example specifically says (the last line) to ignore the time value of money (which means to not discount).
This first example is just a check on relevant costs.

3. says

Sir, you managed to bring a smile on my face even with exam pressures just around the corner. thank you

4. says

Thank You! A great lecture!
But I have 2 questions.
1. If we have to rent the premises specifically for this project, then do we consider it as a relevant cost?
2. Why don’t we consider \$ 40,000 Labour cost as a relevant cost. I get the point why we don’t consider it when we calculate Loss from the other products. But why don’t we take it to account for this project seperately?

• says

If we did rent premises specifically, then we would include them (but we don’t in this question).

With regard to the labour, we will be paying them whether we move them to this project or whether they stay where they are – there is no extra cost involved.

• says

Thanks alot!
I asked about the question regarding premises in case we don’t come across a question with that point in the examples.

5. says

Wow! I just realised that I still remember and understand F5 very well! That’s a surprise! lol!

Thank you Mr John, good stuff.