[Anonymous]

A manufacturing company’s 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 company’s 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 × $50 13,200,000 Production department costs

264,000 × $29.50

264,000 × $21.50

300,000 × $21.50 (6,450,000) Margin 6,750,000 New material:

Units produced 300,000 Good units (98%) 294,000 Revenue

294,000 × $50 14,700,000 Production department costs

294,000 × $29.50

300,000 × $21.50 (6,450,000) 300,000 × $ 2.50

294,000 × $21.50

294,000 × $ 2.50

30,000 × $ 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) ?