Full Question
A company with excess capacity must decide between scrapping or reworking units that do not pass inspection. The company has 13,000 defective units that cost $5.70 per unit to manufacture. The units can be
a) sold as is for $3.30 each, or
b) reworked for $5.00 each and then sold for the full price of $9.00 each.
I) What is the incremental income from selling the units as scrap and reworking and selling the units?
II) Should the company sell the units as scrap or rework them?
Answer:
Incremental Revenue (or income) refers to the additional monies generated from an additional quantity of sales.
A) What is the incremental Income from selling the units as scrap?
Scrap sale price (pu) = $3.30
Manufacturing Cost (u) = $5.70 is a sunk cost.
So If 13000 units are sold as scrap,
Incremental Income = 13000*$3.30
= $42,900
The incremental income from selling the units as scrap is $ 42,900.
B) What is the incremental income from reworking and selling the units?
Recall that Manufacturing cost of $5.70 is a sunk cost with respect to scrap units.
Total cost including cost of reworking for scrap unit
= $5.00+$3.30 =$8.30
Sale price for reworked units is $9.00
So profit per unit (pu) = $9.00-8.30 = $0.70
So Total Incremental income after it has been reworked is
= 13000*0.70
= $9,100
II) The company should sell the product as scrap the Total Incremental Income to the business is obviously higher when sold as scrap than when it is reworked and resold at a higher price.
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