[mhfrdzi]

Sorry, I mean direct labour not direct material

[mhfrdzi]

Yes, I did watch your lecture and I understand that this is an opportunity cost. I calculated it correctly.

However, when I look at the answer given.

(1)Costs to date of $150,000 sunk-Ignore
(2)Materials $5,000
(3)Labour cost ($90,000)
(4)Research staff costs ($60,000)
Wages for the year ($20,000)
(5)equipment ($8,000)
Deprival value if used in the project $6,000
(6)general building services ($7,000)
-Total relevant cash flow associated with the contract ($174,000)
-Sales Value of contract $300,000
-Increased contribution from contract $126,000

I know how to calculate the opportunity cost for the labour which is $90,000.my problem is when we calculate the total relevant cash flow associated with the contract above, I don’t understand why we deduct the $90,000 for the labour cost? Is it because we saved money?

[mhfrdzi]

Why we have to deduct it and not adding it instead?

[mhfrdzi]

A research contract, which to date has cost the company $150,000, is under review.

If the contract is allowed to proceed:

it will be completed in approximately one year
the results would then be sold to a government agency for $300,000.
Shown below are the additional expenses which the managing director estimates will be necessary to complete the work.

Materials

This material for the contract has just been purchased at a cost of $60,000.
It is toxic; if not used in this contract it must be disposed of at a cost of $5,000.
Labour

Skilled labour is hard to recruit.
The workers concerned were transferred to the contract from a production department, and at a recent meeting, the production manager claimed that if the men were returned to him they could generate sales of $150,000 in the next year.
The prime cost of these sales would be $100,000, including $40,000 for the labour cost itself.
The overhead absorbed into this production would amount to $20,000.
Research staff

It has been decided that when work on this contract ceases, the research department will be closed.
Research wages for the year are $60,000, and redundancy and severance pay has been estimated at $15,000 now, or $35,000 in one year’s time.
Equipment

The contract utilises a special microscope which cost $18,000 three years ago.
It has a residual value of $3,000 in another two years, and a current disposal value of $8,000.
If used in the contract it is estimated that the disposal value in a year’s time will be $6,000.
Share of general building services

The contract is charged with $35,000 pa to cover general building expenses.
Immediately after the contract is discontinued, the space occupied could be sub-let for an annual rental of $7,000.
Required:

Advise the managing director as to whether the contract should beallowed to proceed, explaining the reasons for the treatment of eachitem.

(Note: Ignore the time value of money.)

My question is about the skilled labour which is $90,000. According to the answer we have to deduct it.

[mhfrdzi]

Thank you! 🙂

[mhfrdzi]

I did sir. I have already double check it. This is actually an example for sensitivity analysis from Kaplan textbook. I will rewrite the example along with the working given

A manager is considering a make v buy decision based on the following estimates.
Variable production cost:
If made in house: $10
If but in and rebadge:$2

External purchase costs:
If made in house: –
If but in and rebadge:$6

Ultimate selling price:
If made in house: $15
If but in and rebadge:$14

You are required to assess the sensitivity of the decision to the external purchase price.

The working given is;

Step 1: comparin contribution figures the product should be bought in and rebadged

If made in house : contribution is $5
If buy in and rebadge: contribution is $6

Step 2: Calculate the sensitivity (to the external purchase price)
For indifference, the contribution from outsourcing needs to fall to $5 per unit. Thus, the external purchases price only needs to increase by $1 per unit. If the external purchase price rose by more than 17% the original decision would be reversed

Sir, I have problem to understand the step 2.

[mhfrdzi]

Thank you so much sir for your brilliant lectures and for your help . I took FMA last Friday and passed with 70% . Once again thank you so much sir John !:)

[mhfrdzi]

Sir , can you explain why you add up the fixed overhead $4 with the standard profit $5 ? i’m clueless.

[mhfrdzi]

Thank you so much sir for the very clear explanation ! 🙂

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