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Dear John,
How are you?
I hope you are well and safe,
Kaplan Exam kit the following question is presented,
44- The predicted selling price for a product has been set at $56 per unit. The desired mark-up on cost is 25% and the material cost for the product is estimated to be $16 before allowing for additional materials to allow for shrinkage of 20% (for every 10 Kg going in only 8 Kg comes out).
If labour is the only other cost and 2 hours are needed what is the most the business can pay per hour if a cost gap is to be avoided?Solution
1- My APPROACH
since, the selling price = cost + required mark-up
then Selling price =1.25% Cost
Hence, the full cost of the product =56/1.25%
then, the targeted cost = $44.8
to get the cost of labour Hour we should deduct the material cost of the full unit cost
material before the shrinkage $16
the amount of shrinkage =($16*20%shrinkage ratio) =$3.2
then total material cost per unit =$16+$3.2=$19.2
so, labour cost =targeted cost – material cost
=$44.8 – $19.2= $25.6
Direct labour hour per unit are 2 hours
then, the cost of labour hour is as follow = $25.6/2 labour hours =$12.8 Which Is wrong.2- Kaplan APPROACH
Selling price $56
Profit $11.20
target cost $44.80
Material cost (16/0.8) $20
Labour -2 hours 24.80
labour rate per hour=24.80/2=$12.40 Which is correct as per Kaplan Text exam.My question is as follow
Why there is difference in the calculation in material shrinkage amount?
To be honest I don’t know when I should use Kaplan approach to get the material shrinkage /using the same pattern of such equation and when should I use my approach.Please, help me through this.Thank you in advance.
The Kaplan answer is correct.
Even though the material cost is $16 after the shrinkage, the whole material cost does have to be paid for. So the whole cost of the material is indeed $20 and the price charged does have to cover the whole of the costs.
Dear John,
I think you didn’t get my question point clearly,
my question is why the amount of material shrinkage is calculated as the follow,
First method,as per kaplan
Total Material cost (16/0.8) $20
Hence, material shrinkage =$4
not according to the following method 2,
Amount of material shrinkage =16*20%= $3.2
why the material shrinkage is $4 not $3.2?
I don’t know why the material shrinkage amount is different as per the both methods mentioned above,as well as i don’t know which one is correct and why?
and when should i do use the first method and when the second should be used?I hope I made the question a little bit clear for your kind person.
Thank you for your understanding.You are reading the question wrongly.
When it says that the cost is $16 before allowing for shrinkage it means that they have not included the fact that they will have to buy more and that it has not been taken into account.
They will actually need to pay $20, there will be shrinkage of $4 and therefore the cost before allowing for the shrinkage is $16.
Dear sir,
I know they have to pay the whole cost of material for,
But, that’s not my issue iam asking specifically about the calculation of material shrinkage as per me it should be $3.2 as I explained above, but as per Kaplan it is $4.
Could you tell me the difference in calculation, please?What shrinks is not the material that is used but the material that is put in. The material that is used will already have shrunk!!
As I have already explained, if they buy material for $20 and then there is shrinkage of 20% then the shrinkage will be $4 which leaves $16 that is used.
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