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Cleverclogs is short of labour for a new one-off project needing 600 hours of labour and has
choices as to where to source this. He could hire new people temporarily from an agency
at a cost of $9 per hour. Alternatively he could recruit new temporary staff at a fixed cost
of advertising of $1,200 but then only pay $6 per hour for the time. He could also redirect
some staff from existing work who are currently paid $7 per hour and who make sandals
that generate a contribution of $3 per hour after all variable costs. Sandals are a good
selling product and Cleverclogs will lose the production and the related sales whilst staff is
working on the new one-off project.
What is the relevant cash flow?
A $1,800
B $3,600
C $4,200
D $4,800A
The options are:
Agency 600 × $9/hr = $5,400
Internal transfer 600 × (7 + 3) = $6,000
Hire new $1,200 + (600 × $6/hr) $4,800
Cleverclogs would select the lower of the costs and so this is the relevant cash flow sir for internal transfer shouldn’t it be 600 *9+600*3,
(600*(9+3)) because 7 dollars is the existing cost it would be incurred irrespective of the project taken or notLet me explain with a little example.
Suppose that the current work has a selling price of $20, labour of $7, and materials of $10. So a contribution of $3.
If they take the labour for a new job then they lose the revenue of $20 but they save the materials of $10 (they are still paying the labour so no saving there). So they lose a net 20 – 10 = $10 and this is the relevant cost (and is always the same as the contribution of $3 plus the labour of $7).
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