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I just wanted to know whether the following will be regarded as a relevant cost for NPV,
Suppose labour was needed for the new project but due to labour shortages, labour needed to be transferred from another process. I understand that you now need to account for the foregone contribution but what about the labour cost in itself? i.e. given that had the new project not been there we would still pay the same wages, do we exclude that cost?
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Labour shortages in the exam means “FULL CAPACITY” in the other process you refer to.
So the RC is the contribution forgone + the actual wages cost of the personnel transferred to work on the new project>
Regards, Kevin
But in the OT notes chapter 8 example 1 – the relevant cost of labour was taken to be the contribution excluding labour (i.e 150 – (100 – 40) where 150 is sales, 100 prime cost and 40 is wages)
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Hi Liz,
I don’t believe you have interpreted the OT solution correctly – as I have said in my previous post the RELEVANT COST is the contribution forgone + the actual wages cost of the personnel transferred to work on the new project.
Below, I have represented the solution in Chapter 8 – my answer is the SAME but take a look at how I have presented the actual LABOUR Cost:
Cost:Benefit analysis
Based on examination of the Relevant Cash Flows (Relevant Costs)
Schedule of Relevant Costs
Revenue 300,000
Less: Directly Attributable Costs
Materials (5,000)
Labour Cost
– Actual Wages 40,000
– Contribution Lost 50,000* 90,000* Revenue 150,000 – Prime Cost 100,000 = Conribution lost of 50,000
Research Staff
– Actual Wages 60,000
– Severance Pay (35,000 – 15,000) 20,000Equipment (8,000 – 6,000) 2,000
Rental – lost 7,000 174,000
Net Cash Flow (Inflow or Surplus) 126,000
Explanations for Managing Director:
Definition of Relevant Costs:
• Future C/F’s
• Incremental C/F’s
• Direct Revenues and Costs
• Opportunity Costs, etc., etc.,Revenue
– – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
Materials
– – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
Labour
– – – – – – – – – – – – – – – – – – – – – – – – – – – – – – –
….. and so on for each line item in the question as aboveI hope you get it now!
Regards, Kevin Kelly
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