Question

A company with excess capacity must decide between scrapping or reworking units that do not pass inspection. The company has 22,000 defective units that cost $6 per unit to manufacture. The units can be a) sold as is for $2.00 each, or b) reworked for $4.50 each and then sold for the full price of $8.50 each. What is the incremental income from selling the units as scrap and reworking and selling the units

Answer 1

In comparing scrapping or reworking defective units, the company sees an incremental income of $44,000 in favor of reworking and selling the units, notwithstanding both options resulting in a loss.

Step-by-step explanation:

When deciding between scrapping or reworking defective units, a company with excess capacity should consider the incremental income from both options. Given the costs to manufacture are $6 per unit, and there are 22,000 units, we have two scenarios:

• Option A: Selling as scrap - The defective units can be sold as is for $2.00 each, resulting in a total revenue of $44,000 (22,000 units x $2/unit).
• Option B: Reworking and selling - The defective units can be reworked for $4.50 each and sold for $8.50 each. Reworking costs are $99,000 (22,000 units x $4.50/unit), and total revenue after rework is $187,000 (22,000 units x $8.50/unit).

To calculate the incremental income, we consider the net gain from both options:

1. Net gain from Option A (scrapping): $44,000 (total revenue) - $132,000 (manufacturing cost) = -$88,000 (loss).
2. Net gain from Option B (reworking and selling): $187,000 (total revenue after rework) - $132,000 (manufacturing cost) - $99,000 (reworking cost) = -$44,000 (loss).

The incremental income is the difference in losses between the two options, which is -$44,000 - (-$88,000) = $44,000 favoring Option B (reworking and selling).