[I'm, Ron Burgundy?]

Please take a look at the question below and the answer explanation:

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

$1,425,000

$ 120,000

$ (120,000)

$ 750,000

And here’s the answer explanation:

Answer: 750,000. 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

MY QUESTION IS:

Why are they using the same Costs of 21.50 used in the original scenario? If the Direct Materials increase by $2.50 would that not increase the product cost to $24? There is something I’m missing here. Any help would be greatly appreciated.

"If you're going through hell, keep going"
- Winston Churchill

"I've missed over 9,000 shots in my career. I've lost over 300 games. 26 times I've been trusted to take the game winning shot, and missed. I've failed, over and over and over again in my life. And that is why, I succeed."
- Michael Jordan

BEC: (54), (72), 80 (losing credit on 02/02/15 - nervous)
AUD: 78
REG: (74), 91
FAR: (71)

[rlg5150]

I just look at it like this:

Old cost

264,000 x $50.00 = $13,200,000 Revenue

300,000 x $29.50 = $8,850,000 Cost

$13,200,000 – $8,850,000 = $4,350,000 Profit

New Cost

294,000 x $50.00 = $14,700,000

300,000 x $32.00 = $9,600,000 Cost

$14,700,000 – $9,600,000 = $5,100,000

$5,100,000 – $4,350,000 = $750,000

FAR - 85
AUD - 86
BEC - 84
REG - 88

[Author]

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