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UU Company has been asked to quote for a special contract. The following information
about the material needed has been given:
Material X:
Book value:$5.00 per kg
Scrap value: $0.50 per kg
Replacement cost: $5.50 per kg
The contract requires 10 kgs of Material X. There are 250 kgs of this material in inventory
which was purchased in error over two years ago. If Material X is modified, at a cost of
$2 per kg, it could then be used as a substitute for material Y which is in regular use and
currently costs $6 per kg.
What is the relevant cost of the materials for the special contract?1. The answer is $40.
2. Could you explain the logic behind why the net save of $4( $6-$2) is the relevant cost?
– Why the $6 is not the relevant cost?If they take material X for the contract then they will have to spend $6 buying material Y.
If they do not take material X for the contract then they will spend $2 to modify it and use it instead of material Y.
So the extra cost of taking material X for the contract is 6 – 2 = $4.
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