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Topic
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A manufacturing companyās primary goals include product quality and customer satisfaction. The company sells a product, for which the market demand is strong, for $50 per unit. Due to the capacity constraints in the Production Department, only 300,000 units can be produced per year. The current defective rate is 12% (i.e., of the 300,000 units produced, only 264,000 units are sold and 36,000 units are scrapped). There is no revenue recovery when defective units are scrapped. The full manufacturing cost of a unit is $29.50, including
Direct material $17.50 Direct labor 4.00 Fixed manufacturing overhead 8.00
The companyās designers have estimated that the defective rate can be reduced to 2% by using a different direct material. However, this will increase the direct material cost by $2.50 per unit to $20 per unit. The net benefit of using the new material to manufacture the product would be?
-Here is the solution:
This answer is correct. This solution includes the variable cost of the 300,000 units produced as well as the $2.50 incremental variable cost for the new direct material. See supporting calculations.
Supporting calculations
Original:
Units produced $300,000 Good units (88%) 264,000 Revenue
264,000 Ć $50 13,200,000 Production department costs
264,000 Ć $29.50
264,000 Ć $21.50
300,000 Ć $21.50 (6,450,000) Margin 6,750,000 New material:
Units produced 300,000 Good units (98%) 294,000 Revenue
294,000 Ć $50 14,700,000 Production department costs
294,000 Ć $29.50
300,000 Ć $21.50 (6,450,000) 300,000 Ć $ 2.50
294,000 Ć $21.50
294,000 Ć $ 2.50
30,000 Ć $ 2.50
Margin 7,500,000 Increase
(decrease) $750,000
Why do they separate the fixed and variable costs calculation? Why not just use $50 – (17.50+4+8) ?
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