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Dear Tutor,
I have a question from the exam kit from Kaplan, Q: 66
P is considering whether to continue making a component or to buy it from an outside
supplier. It uses 12,000 of the components each year.
The internal manufacturing cost comprises:
$/unit
Direct materials 3.00
Direct labour 4.00
Variable overhead 1.00
Specific fixed cost 2.50
Other fixed costs 2.00
–––––
12.50
–––––
If the direct labour were not used to manufacture the component, it would be used to
increase the production of another item for which there is unlimited demand. This other
item has a contribution of $10.00 per unit but requires $8.00 of labour per unit.What is the maximum price per component, at which buying is preferable to internal
manufacture?
A $8.00
B $10.50
C $12.50
D $15.50The answer is D.
There is a working for labour costs
W1) Relevant cost = Contribution Forgone + Direct labour = $10/2 + $4 = $9.Could you please explain to me the meaning of $10/2? I hought that the contribution forgone would be 10-8.
Kind regards
I think I misread the question 10 is the contribution and not the revenue. Is the 10/2 (8/4) because the other item requires 2x labour compared to the first?
The relevant cost is the contribution plus the labour. As you have realised, component takes half the time of the “other item” (because the labour is only $4 but is $8 for the other item), and therefore the contribution foregone for each component is half of the contribution for the other item.
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