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1) LW Co has a half empty factory on which it pays $5,000 pa rent. If it takes on a new project, it will have to move to a new bigger factory costing $17,000 pa and it could rent the old factory out for $3,000 pa until the end of the current lease.
What is the rental cost to be included in the project appraisal?
A $14,000
B $17,000
C $9,000
D $19,0002)A new project being considered by BLW Co would require 1,000 hours of skilled labour. The current workforce is already fully employed but more workers can be hired in at a cost of $20 per hour. The current workers are paid $15 per hour on a project that earns a
contribution of $10 per hour.
What is the relevant cost of labour to be included in the project appraisal?
A $10,000
B $15,000
C $20,000
D $25,000Well these relevant costing questions have always been difficult for me.
According to me the answer to question 2 should be B because relevant cost are lost contribution plus the cost of paying the extra rate to labor.But the correct answer is C.
The answer of question no 1 is A because we have to take account of the extra amount we have to pay for taking a project.But why the same logic does not apply to question 2?
Some explanation will be helpful.There is not really any connection between the two questions.
For question 1, they will still be paying the 5,000 rent whatever happens and so this is not relevant.
If they do the new project they will have to pay 17,000 a year, but will be able to receive 3,000 a year from renting out the existing factory.
So a net relevant cost of 14,000.For question 2, if they use the current workforce then the cost will be $25 per hour (last contribution plus the labour cost). However, instead of using the current workforce, they have the option to leave the workers where they are and hire more workers at a cost of $20 per hour. It is cheaper to hire more workers and so that is what they will do, and therefore the relevant cost is $20 per hour.
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