Question

Structuring the Sell-or-Process-Further Decision

Bart’s Butters receives 1,000,000 containers of raw milk each period that it subsequently processes into consumable milk by adjusting the fat content, adding vitamins, and destroying any potentially harmful bacteria. For Bart’s, one container equals one gallon of consumable milk. Bart’s then must decide whether to sell its consumable milk at split-off or to process it further into butter. Bart’s normally sells consumable milk for a per-gallon price of $3. Alternately, each gallon of milk can be processed further into one-half tub of butter (i.e., one gallon of milk equals 0.5 gallon of butter) at an additional cost of $1.50 per tub of butter. Also, butter can be sold for $6.00 per tub.
Required:
1. What is the contribution to income from selling the consumable milk?
2. What is the contribution to income from processing the consumable milk into butter?
3. Should Bart’s continue to sell the consumable milk or process it further into butter?

Answer 1

a. The contribution to income from selling the consumable milk is:

= 1,000,000 gallon * $3

= $3,000,000

b. The contribution to income from processing the consumable milk into butter is:

= (1,000,000 gallon*0.5 gallon) * ($6 - $1.50)

= 500,000 gallon * $4.50

= $2,250,000

c. Bart's should continue to sell the consumable milk, rather than processing the consumable milk into butter due to high contribution of $750,000 ($3,000,000 - $2,250,000).