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1) Material not in inventory:
If there is no material in inventory. All new materials will be bought from supplier.RC = material units required x current purchase cost
2) Material exists in inventory but is regularly used:
If materials already exist in inventory & regularly used in the production then we need to purchase new material from the supplier.RC = material units required x current purchase cost
3) Material exist in inventory but not regularly used:
If materials already exist in inventory & no other use of them in the production except for using them in the contract. There is an opportunity cost either of not selling the materials to the scrap OR alternative use of material in the usual production is foregone because we are using material in the contract. BUT any additional material in inventory will be bought from supplier.RC = opportunity cost
higher of: (1) Scrap value (2) Net Benefit from Alternative use foregone OR other use]Net Benefit is actually the lost contribution which is the income that we lose from the current project because we are using the existing material into the contract. (why the lost contribution is called the net benefit because to get the net we need to less something from the benefit. correct?)
For example, if the company’s material is used in the existing project which is making $20,000 income but if we use the same material kilos in the contract we will lose $20,000 income which we would have been earning from the project so we need to compensate for the lost income from the contract. (correct?)
I am seen your video on this but I need to know this. If I am wrong anywhere please correct me?
Thank you.
Thanks for the response. SIR 🙂
But I asked you a question regarding point (3) which says that relevant cost is an opportunity cost when the material kilos are limited to satisfy both the existing project as well as the contract requirement.
(1) I need to know how to calculate opportunity cost whether there is any fixed rule to calculate the opportunity cost or not?
(2) Opportunity cost is sometimes referred to as net benefit foregone (i.e. benefit lose from alternative use or other use) in the Kaplan and BPP study texts but I do not know what does that mean.
(3) Net Benefit is the contribution / profit from the existing project which we lose and any cost will be deducted from the profit to get the net benefit (correct?)
Could you please explain the points above and how to calculate them?
Opportunity costs are always the net benefit foregone.
What is means is whatever net income is lost as a result of doing the new project, which might for example be the lost contribution from other products because we lose some production, or it might be simply the lost scarp proceeds from some inventory that is used in the new project.
How they are calculated depends on the information given in the question and you can only really learn it by watching my free lectures on this and by practicing all of the questions in your Revision Kit.
So thanks for making that clear 🙂
There is another situation where we need to modify the material to use for the contract.
It is a kaplan kit question that says:
The contract requires 10 kgs of material X. There are 250 kgs of this material in inventory which was purchased in error over two years ago. If material X is modified at a cost of $2 per kg. It could then be used as a substitute for material Y which is in regular use and currently cost $6 per kg.It is an opportunity cost question. correct?
Could you please also explain what is really happening in this question and how can we answer. I am really confused with this.
If they do not do the new contract then they will take the 10kg and modify it as a cost of $2 to use instead of material Y. Therefore they will pay $2 for modifying but save $6 by not having to buy material Y. So it will save them a net $4.
If however they take the material for the new contract they will be able to make this saving of $4. Therefore the relevant cost (which is an opportunity cost) is the lost saving of $4 per kg.
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