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A special job for a customer will required 8 tonnes of a Material M. The company no longer uses this material regularly although it holds 3 tonnes in inventory. These originally cost $44 per tonne, and could be resold to a supplier for $35 per tonne. Alternatively these materials could be used to complete another job instead of using other materials that would cost $126 to purchase. The current market price of Material M is $50 per tonne.
The company must decide whether to agree to the customer’s request for the work, and to set a price. What would be the relevant cost of Material M for this job?The solution provided by BPP is as follow:
Additional purchases (5 tonnes × $50) = $250
Relevant cost of material M already held (higher of $126 and (3 × $35)) = $126
Relevant cost total = $376I dont understand why relavant cost of materia M already held equal to higher of $126 and (3 x $35). Please help me make it easier to understand.
Thank you so much.
If they did not use the 3 tonnes in this special job, there are two things they could do with the material. They could either sell them and get 3 x $35 = $105, or alternatively they could use them in another job and save themselves $126 (because they would not need to buy other materials.
So if they did not use the 3 tonnes in the special job, they would use them in the other job (because they would rather save 126 then receive 105) and would therefore save 126.They are using them in this special job, so they will not be saving 126 and therefore 126 is the relevant cost (the opportunity cost).
Thank you for your reply, whether the relevant cost for 3 tonnes is the opportunity cost in this case.
It means that the relevant cost equal to the biggest value of althernative solutions comprised of selling the materials already held at $105 and purchasing other materials at $126.Am I understand right?
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