Q 1: materials

A company is considering making a new product which requires several types of raw material:

  Units Units Additional information

in inventory required

Material Nil 40 Current purchase price is $7/unit.

A

Material 100 purchased 150 Current purchase price is $14/unit. The material has no use in
B for $10/unit the company other than for the project under consideration.
Units in inventory can be sold for $12/unit.

Material 50 purchased 120 Current purchase price is $22/unit. The material is regularly
C for  $20/unit used in current manufacturing operations.

What is the relevant cost of the materials required for manufacture of the new product?

Solution:
Material A – There is no inventory, all 40 units required will have to be bought in at $7 per unit. This is a sh
outflow caused by the decision to make the new product. The relevant cost of Material A (40 units x $7) =
$280.
Material B - The 100 units of the material already in inventory has no other use in the company, so if it is not
used on the new product, it would be sold for $12/unit. If the new product is made, this sale won’t happen
and the cash flow is affected. The original purchase price of $10 is a sunk cost and so is not relevant. In
addition, another 50 units are needed for the new product and these will need to be bought in at a price of
$14/unit.
The total relevant cost for Material B is:

100 units x $12 (lost sale proceeds) = $1,200

50 units x $14 (current purchase price) = $700

  $1,900

Material C – This material is regularly used in the company, so if the 50 units in inventory are diverted to the
new product then this will mean that inventory will need to be replenished. In order to do this, Material C
purchases for existing products will be accelerated by 50 units. The current purchase price of $22 will be
used to determine the relevant cost of Material C as this will be the value of each unit purchased. The
original purchase price of $20 is a sunk cost and so is not relevant. Therefore the relevant cost of Material C
for the new product is (120 units x $22) = $2,640
Q2: labour
A company has aproject which requires the following three types of labour:

  Hours Additional information

required

Unskilled 12,000 Paid at $8 per hour and existing staff are fully utilised. The company
will hire new staff to meet this additional demand.
ANSWER $96,000

Semi-skilled 2,000 Paid at $12 per hour. These employees are difficult to recruit and the
company retains a number of permanently employed staff, even if
there is no work to do. There is currently 800 hours of idle time and
any additional hours would be fulfilled by temporary staff that would
be paid at $14/hour.
1200 x14 16800
800 nil $

Skilled 8,000 Paid at $15 per hour. There is a severe shortage of employees with
these skills and the only way that this labour can be provided for the
new project would be for the company to move employees away from
making Product X. A unit of Product X takes 4 hours to make and
makes a contribution of $24/unit.
Normal – 8000 x15 = 120,000
Opp cost- 8000x6= 48,000 or 24 x 2000 toal 168,000

What is the relevant cost of the labour hours required for the new project?

Q3

R Co needs to use two materials, BLUE and GREEN, in a project. The following information about the
two materials is available:
Kgs in Original Replacement cost Realisable Kgs needed
inventory price value for project
Material Blue 5 $6 $7 $5 10
Material Green 12 $8 $11 $10 8

Material Blue is regularly used in the business. Material Green is held in inventory as a result of over
stocking some months ago and has no other use in the business.

What is the relevant cash flow for the materials that should be included in the project ?

Material Blue$ 70 AND Green $80

Q4
A company has material B in its inventory, which it purchased in error at a cost of $800.

The company is deciding whether to:

(i) use it as a substitute for material A which would cost $500 to buy in; or
(ii) sell material B for $510 cash LESS selling costs of $20; or
(iii) use it in another contract.

If the company decides to use the material in another contract, what is its relevant cost?

USE AS SUB $ 500

SELL OF $ 510-20 = $ 490

Use in ANOTHER CONTRACT

THE HIGHER OF RESALE VALUE VERSUS SUBSTITUTE for A
↓ ↓
490 500
Honestly the BEST deal for that Material is the $500 as it is more valuable to COMPANY.thats why
the the higher of is chosen.

Q5

A company currently has as old machine. This machine was bought at $ 30,000 and is estimated to
last 5 years. The annual depreciation is 20% per annum on cost. At the moment it is not used for any
work and idle.

Company has now received a special project. This new special project would need to use the above
machine for 3 months . At present the resale value of the machine is $11,000 . It is believed that
after using the machine for the project the resale value will not change. The net book value of the
machine is $12,000. Using it for the project would require a bit of servicing at a cost of $80.

Routine maintenance for the 3 months would be $ 65 per month . Current routine maintenance is
$30 per month. Required Determine the cost of using the machine for the project. ANSWER

Servicing cost $80

Routine maintenance $35x3 $ 105….$185