Question

Come-Clean Corporation produces a variety of cleaning compounds and solutions for both industrial and household use. While most of its products are processed independently, a few are related, such as the company’s Grit 337 and its Sparkle silver polish.

Grit 337 is a coarse cleaning powder with many industrial uses. It costs $1.60 a pound to make, and it has a selling price of $2.00 a pound. A small portion of the annual production of Grit 337 is retained in the factory for further processing. It is combined with several other ingredients to form a paste that is marketed as Sparkle silver polish. The silver polish sells for $4.00 per jar.

This further processing requires one-fourth pound of Grit 337 per jar of silver polish. The additional direct costs involved in the processing of a jar of silver polish are:

Other ingredients	$	0.65
Direct labor		1.48
Total direct cost	$	2.13

Overhead costs associated with processing the silver polish are:

Variable manufacturing overhead cost		25%	of direct labor cost
Fixed manufacturing overhead cost (per month)
Production supervisor	$	3,000
Depreciation of mixing equipment	$	1,400

The production supervisor has no duties other than to oversee production of the silver polish. The mixing equipment is special-purpose equipment acquired specifically to produce the silver polish. Its resale value is negligible and it does not wear out through use.

Direct labor is a variable cost at Come-Clean Corporation.

Advertising costs for the silver polish total $4,000 per month. Variable selling costs associated with the silver polish are 7.5% of sales.

Due to a recent decline in the demand for silver polish, the company is wondering whether its continued production is advisable. The sales manager feels that it would be more profitable to sell all of the Grit 337 as a cleaning powder.

Required:

1. What is the incremental contribution margin per jar from further processing of Grit 337 into silver polish? (Round your answer to 2 decimal places.)

2. What is the minimum number of jars of silver polish that must be sold each month to justify the continued processing of Grit 337 into silver polish? (Round your intermediate calculations to 2 decimal places.)

Answer 1

1. Incremental Revenue from further processing GRIT 337 into silver polish = $ 4.00 - $ 2.00 / 4 = $ 3.50.

Incremental costs of further processing = $ 2.13 + $ 1.48 x 0.25 = $ 2.50

Variable selling costs per jar of silver polish = $ 4.00 x 7.5% = $ 0.30

Incremental contribution margin per jar = $ 3.50 - $ 2.50 - 0.30 = $ 0.70

2. Total traceable fixed cost = Supervisor's salary + Advertising Expenses = $ 3,000 + $ 4,000 = $ 7,000.

The book value of the equipment is a sunk cost, and therefore, depreciation is not relevant for decision making here.

The minimum number of jars that must be sold each month = Traceable Fixed Cost / Contribution Margin per Unit = $ 7,000 / $ 0.70 = 10,000 units.