[Anonymous]

A manufacturing 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 $29.5, including

Direct material $17.5

Direct labor 4

Fixed manufacturing overhead 8

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 $2.5 per unit. The net benefit of using the new material to manufacture the product would be

A. (120,000)

B. 750,000

C. 120,000

D. 1,425,000

I picked A and it is wrong. The answer is B. However, I dont know why it is B. Can anyone help? Please

[mahalohui]

Answer B is correct which can be concluded as follows:

Incremental revenue = 1,500,000 (30,000 units x $50 selling price)

Incremental costs = 750,000 (300,000 units x $2.50 DM)

Net Benefit = 750,000

Since the defective rate is expected to drop from 12% to 2% using the new DM, then it would result in a decrease in scrap units of 36,000 to 6,000. So in result, the company has 30,000 more units in inventory for sale. For the incremental costs, you would have to take the additional $2.50 increase in DM per unit and times it by units produced which is 300,000.

FAR - 93
AUD - 98
REG - 92
BEC - 92

[Author]

Replies