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thank you for the lecture, however I was wondering if you can clarify something for me in exercise 2 (page 65 of the lecture notes)
Note 5 says that machine overheads are $3 p/h and the contract is estimated to require 6000hrs. It states that 4000hrs are free with 2000 having to be taken from another job. When calculating the relevant costs, these have been done at 6000hrs x $3 for the machine overheads + 2000 x $2 for the lost contribution.
However I am wondering why the cost is 6000hrs x $3 when 2000 of those hours are already included in the other project and if the contract didn’t take place we would incur that cost regardless.
Would the incremental cost not be the 4000hrs instead? Have we not accounted for the 2000hrs when working out the opportunity cost for lost contribution (which would be selling price less machine overheads, labour etc.)If you could clarify it would be appreciated.
Rob
Hi there – this is a common misunderstanding – but definitely is stated correctly in the example.
When resources are diverted from alternative use (labour hours or as here use of a machine time ) – then the cost of this is:the contribution forgone + the variable cost per hour of using the machine
The reason is because by stating we are losing the contribution (you are effectively saying you are losing the sales revenue less the variable cost of the other job) – whereas you are not losing the variable cost here – it will still be incurred so we add it back on.
I hope that explains ok …
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