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Good Afternoon John,
I hope you are well. I find your lectures very very useful it has helped me a lot!! Thanks for all your hard work running this site and helping many students like me!!
Could you help me with the following question please?A new project needs 600 labour hours and the choices are:
-hire someone with agency- cost £9/hour
-advertise: fixed advertising cost £1200
new member of staff cost £6/ hour
-or move existing staff over who is currently on £7/ hour and generate £3/hour contribution.My answer was:
1st option:
600*£9= £54002nd:
fixed advertising cost: £1200
plus 600*£6= 3600
Total:£48003rd:
existing staff wage would be not relevant- we pay him any which ways
but we lose £3/hour contribution
so £3*600=1800And the answer was in the book option 2.
They said in option 3 we need to add labour cost to lost contribution.
so £3*600=1800
plus £7*600=4200
Total: £6000I don’t understand why they added the labour cost on. It would be paid anyway.
Thanks for your help in advance!
PeterIt is true that they will still be paid.
However look at this simple example:
Suppose they currently make an item for which the revenue is 100, the labour is 10, and the other variable costs (material etc) are 20. So the contribution is 70.
If the labour is taken for another project, then they will still pay the labour. However they will lose the revenue of 100, and they will save on the other variable costs of 20. So they will lose a net 80 (and this will be the relevant cost. This is equal to the contribution plus the labour (70 + 10 = 80) and always will be equal to the contribution plus the labour 🙂
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