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A company has received a special order for which it is considering the use of material B, which it has held in its inventory for some time. This inventory of 945kg was bought at $4.50 per kg. The special order requires 1,500 kg of material B. If the inventory is not used for this order, it would be sold for $2.75 per kg. The current price of material B is $4.25 per kg.
What is the total relevant cost of material B for the special order (to two decimal places)?
Answer:
Incremental purchases = (1,500-945) x $4.25 = $2,358.75
Opportunity cost of materials already purchased = 945kg x $2.75= $2,598.75
Total relevant cost = $2,358.75 + $2,598.75 = 4,957.50From what I have understood, I have done the below calculation:
Purchases (1,500kg x $4.25) = 6,375
Sales = 945kg x $2.75 = 2,598.75
Then relevant costs would have been $3,776.25Could you please explain the answer?
Firstly, the will not be buying 1,500 kg because 945 kg will be taken from the inventory. So they will only be buying 1,500 – 945 = 555 kg and for these they will have to pay $4.25 per kg..
The 945 kg in inventory would otherwise have been sold as scrap for $2.75 per kg.. If instead they are used for the contract then they will lose the income that they would otherwise have received (and opportunity cost).
I do suggest that you watch my free lectures on relevant costing in which all of this is explained.
The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.
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