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The predicted selling price for a product has been set at $56 per unit. The desired mark-up on cost is 25% and the material cost for the product is estimated to be $16 before allowing for additional materials to allow for shrinkage of 20% (for every 10 kg of material going in only 8 kg comes out).
If labour is the only other cost and 2 hours are needed what is the most the business can
pay per hour if a cost gap is to be avoided?Question: I found confusing below mentioned sentence. Could you please explain me this?
“The desired mark-up on cost is 25% and the material cost for the product is estimated to be $16 before allowing for additional materials to allow for shrinkage of 20% (for every 10 kg of material going in only 8 kg comes out)”To get the target cost for the product it can be calculated by dividing the selling price by 1.25 (to account for the desired mark-up of 25%). In this case, the target cost is $56/1.25 = $44.80.
Then to determine the maximum amount the business can pay per labor hour, we need to subtract the material cost from the target cost.
The material cost is estimated to be $16 before allowing for shrinkage. For every 10 kg of material going in, only 8 kg comes out, so the material cost per unit is (10/8) * $16 = $20.
Therefore, the maximum the business can pay per labour hour to avoid a cost gap is $44.80 – $20 = $24.80.
As labour is 2 hours then the labour rate per hour is $12.40
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