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Determine Opportunity Costs
A company has material B in stock that originally cost Shs. 5000 for the 1000 Kshs in stores. The material is missing over from an old purchase order. The company is still considering employing it on contract X. The alternative course of action to utilizing material on contract X is as:
a) 600 kg could be employed in contract Y instead of buying similar material at Shs. 3 per kg.
b) A further 250 kg could be sold like scrap at Shs. 1 per kg
c) The remainder will have to be disposed at a cost 50 pence per kg
Required
Prepare a summary that shows the opportunity cost of utlizing material B on contract X
Solution
The information may be presented in more than one way. An approach that focuses on each individual cash flow for each alternative is useful where the decision making condition becomes more complex, since it adopts a detailed analysis, that is easy to follow. Alternatively, the net costs and benefits may be summarized for employ in the alternative option decision.
a) Showing all relevant cash flows
Accepted Contract
Reject the contract
X
Cash in flows
Scrap sales (250 kg x Shs. 1.00)
250
Nil
Cash outflows
Contract Y purchases (600 kg x Shs. 3)
1800
-
Disposal cost (150 kg x Shs. .5)
75
Net cash inflow/outflow
(1800)
175
The opportunity cost net outflow if material B is essential on contract X is Shs. 1975 . Utilizing a net costs and benefits summary if material B is used on contract X:
Shs.
Benefits
Disposal cost avoided
Less costs
Contract Y purchases
1,800
Scrap sales foregone
2,050
Opportunity cost
1,975
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