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Hi Sir John
Hope you are well. I have a small confusion with respect to relevant cost MCQ.
The question says that labor is already employed at $10 per hour. But if we use it in new project the opportunity cost would be the contribution which is $12 per hour. As no matter if we use labor for new project or not the $10 would be paid so should not be our relevant cost be only $12. The solution says that the relevant cost will be $22 (10+12).
I don’t know where you found this question but it more relevant for Paper PM than for Paper FM.
The correct answer is indeed $22.
Here is a simple example to explain:
Suppose the product they are currently making has a selling price of $50, materials cost of $20, and labour cost of $10. It takes one hour to make.
If they take the one hour for a new product (and so cannot make the current product), they will lose the revenue of $50, they will save the materials of $20, but they will still be paying the labour of $10. So the contribution is $20.
So the net loss from not making the current product is $30 and this is the relevant cost. It is equal (and will always be equal) to the lost contribution of $20 plus the labour cost of $10.
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