Question

PA11. LO 10.5 Quality Clothing, Inc., produces skorts and jumper uniforms for school children. In the process of cutting out the cloth pieces for each product, a certain amount of scrap cloth is produced. Quality has been selling this cloth scrap to Jorge’s Scrap Warehouse for $3.25 per pound. Last year, the company sold 40,000 lb. of scrap, which would be enough to make 10,000 teddy bears that the management of Quality is now interested in producing. Their processes would need some reprogramming, particularly in the cutting and stitching processes, but it would require no additional worker training. However, new packaging would be needed. The total variable cost to produce the teddy bears $3.85. Fixed costs would increase by $95,000 per year for the lease of the packaging equipment and Quality estimates it could produce and sell 10,000 teddy bears per year. Finished teddy bears could be sold for $18.00 each. Should Quality continue to sell the scrap cloth or should Quality process the scrap into teddy bears to sell?

Solution

	Sell at Split-Off	Process Further
Selling price per lb. of scrap
Selling price per teddy bear
Variable costs to sell
Contribution margin
Units sold
Total contribution margin
Additional fixed costs
Effect on operating income

Decision:

Answer 1

	Sell at Split-Off	Process Further
Selling price per lb. of scrap	3.25
Selling price per teddy bear		18
Variable costs to sell	0	3.85
Contribution margin	3.25	14.15
Units sold	40000	10000
Total contribution margin	130000	141500
Additional fixed costs	0	95000
Effect on operating income	130000	46500
Decision	Sell at Split-off
Please use (-) sign for variable cost and fixed cost, if there is any instruction
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