Situation 3 Sell or Process Further 15 Points The Scottie Sw

Situation 3: Sell or Process Further (15 Points) The Scottie Sweater Company produces Sweaters under the \"Scottie\" label. The company buys raw wool and processes it into wool yarn from which the sweaters are woven. One spindle of wool is required to produce one sweater. The costs and revenues associated with the sweaters are given below: Per Sweater $30.00 Selling price Cost to manufacture Raw materials Buttons, thread, lining S 2.0 0 Wool yarn Total Raw Materials Direct labor Manufacturing overhead 16.00 18.00 5.80 8.70 32.50 Manufacturing Profit (loss) $(2.50) Originally, all of the wool yarn was used to produce sweaters, but in recent years a market has developed for the wool yarn itself. The yarn is purchased by other companies for use in production of wool blankets and other wool products. Since the development of the market for the wool yarn, a continuing dispute has existed in the Scottie Sweater Company as to whether the yarn should be sold simply as yarn or processed into sweaters. Current cost and revenue data on the yarn are given below.

Solution

1. The decision should not be taken based upon the Manufacturing profit of the two products. Instead it should be based upon contribution per unit of each product since Manufacturing profit takes into account the manufacturing overheads which are fixed and hence are SUNK COST. i.e. they are irrelevant for decision making, they will continue to occur whether or not sweater is manufactured.

Contribution = Sales - Variable cost

Contribution per unit (Sweater) = 30 - 2 - (16 - 5.4) - 5.8 = $11.6

Contribution per unit (Spindle of yarn) = 20 - 7 - 3.6 = $9.4

Since the contribution per unit is more in case of Sweater, the wool yarn should be processed into Sweater.

2. Lowest price that the company should accept = Variable cost incurred + Contribution to be lost

Variable cost incurred = 2 + (16 - 5.4) + 5.8 = $18.4

Contribution to be lost (Contribution on sale of Yarn) = $9.4

Lowest price that the company should accept = 18.4 + 9.4 = $27.8