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Hello,
I am a bit confused about which costs should be taken into account in investment appraisal, specifically regarding contribution and labour. I have seen one question answered by including both contribution foregone and the labour costs as cash outflows, and another question where only the lost contribution is taken into account. In both cases the workers would have been diverted from other work.
Could you explain which it should be ? I think the former is right but then I really can’t understand how the other question I am looking at is correct.
Thank you,
The former is right, but without seeing the specific question it is impossible for me to explain why they have done differently (or to tell you they have made a mistake if that is the case).
OK, I will revisit the question and have another go! thank you for clarifying.
Hi john, sorry to gate crash this thread but my question is similar to Sarah’s.
It’s regarding relevant costs:
A new project would require 1000 hours of labour. The current workforce is already fully employed but more workers can be hired at a cost of $20 per hour.
The current workers are paid $15 per hour on a project that earns $10 contribution.
What is the relevant cost of labour?Bpp Answer: $20,000 ($20×1000 hours)
This is part of bpp’s explanation which i don’t understand:
Cost to divert existing labour =
Lost contribution + labour cost ($10+$15 x1000 =$25000)My answer would have been $10,000x $15=€15000
Would you mind telling me why we have to include the $10 per hour when calculating the above please?
Thanks
BPP are correct and I explain this in two different ways in the lecture.
If the contribution is $10, then this is after charging labour of $10. So the amount earned (before labour) must be $25.
If you move the labour to the contract, then you are still paying the $10 – so no difference there – but you will need to be earning $25 from the contract to replace the $25 from where they currently are.
If you are not happy with this way of explaining, then you will have to watch the lecture where I explain it another way. Once you have got it then learn it as a rule – it is always cost of labour plus lost contribution in this sort of question.
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