Relevant Costs

There are 5 special studies 1. Discontinuation 2. make or Buy 3. Special Price 4. product mix where capacity contraints exist 5. Replacement of equipment

The Relevant Cost of Direct Labor Short term considerations:If the firm has spare capacity and DL is paid a salary then the Relevant cost is ZERO, Otherwise make it relevant If the form does not have spare capacity then the relevant cost per hour is the hourly rate plus the lost contribution per hour that is lost by taking this work

The Relevant Cost of Direct Materials If the material come from stock then the relevant cost is zero If the material has to be bought the relevant cost is the replacement cost

The Relevance of Fixed Costs Fixed Costs are only relevant if the decision causes more FC to be purchased. For Instance the purchase of a new machine or the addiotnal depreciation of the machine

Capacity constraint Calculate the contribution per limiting factor for each component and rank them. Example the Contribution per unit is $13. The number of hours required is 6. Therefore the contribution per machine hour is 2. Then allocate those hours until they are all used up according to the ranking Calculate the Contribution in total and subtract the FC if the question asks for a Profit Figure

Also remember Qualitative factors

• If you outsource you lose capability for good - It is a l-t decision
• What about the quality of the outsourcing / reliability
• what else could you do that would earn more
• what will happen in following year, to material prices, labor costs, contract prices
• do some Sensitivity Analysis. How much does one factor have to fall to change the decision

DISCONTINUATION HERE

REVIEW QUESTIONS IN CHAPTER TWO