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G Co is preparing a tender for a new contract. This contract requires 600 hours of skilled labour. Skilled labour is paid at $17 per hour. There is a shortage of skilled labour, as all employees are currently fully employed in the manufacture of product H:-
Selling Price $120
Skilled Labour $34
Variable costs $20
Contribution $66What is the relevant cost of labour?
Answer is $30000I understand that if we to undertake the new contract we cannot make H, meaning that product H = labour 2 hours per unit (34/17) 300 units will be foregone therefore lost contribution is $19800 (300*66)
But why are they including the labour in the calculation 600hrs at $17
I understand that they were at full capacity, but surely if we do not make one and make the other there is no extra labour needed?
please help, I am misunderstanding somethingLet me explain with a little example.
Suppose they currently make a product that takes 1 hour per unit. The selling price is $50, materials are $20, and labour is $5. So the contribution is $25 per unit.
If 1 hour is taken for a new contract then they lose the revenue of $50 but the save the materials of $20. (They will still be paying for the labour).
So the net amount lost (and therefore the relevant cost) is 50 – 20 = $30. This is the same (and is always the same) as the contribution ($25) plus the labour ($5).
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