Question

A company with excess capacity must decide between scrapping or reworking units that do not pass inspection. The company has 16,000 defective units that cost $5.50 per unit to manufacture. The units can be a) sold as is for $2.60 each, or b) reworked for $4.90 each and then sold for the full price of $8.10 each. What is the incremental income from selling the units as scrap and reworking and selling the units? Should the company sell the units as scrap or rework them? (Enter costs and losses as negative values.)

	Sale as Scrap	Rework
Incremental income (loss)
The company should:

Answer 1

1) Defective units = 16,000
Case-1) Selling the units as scrap
Total income from sale of defective units as is = [No. of units * Price per unit] = 16,000 *2.6 = $41,600
Company is selling additional 16,000 units @ 8.10 each = 129,600
Incremental income = 41,600 + 129,600 = 171,200
Costs associated with incremental income = 16,000 + 16,000 = 32,000
Cost per unit = $5.50 per unit
Total cost = 32,000 * $5.50 = 176,000
Profit/Loss = [Income - Cost ] = 171,200 - $176000 = 4,800

Case-2) Reworking the units:
No. of units = 16,000
Income per unit = $8.10
Income = 16,000 * 8.10 = 129,600
Costs assciated = [Cost of making + Cost of rework] = 5.50 + 4.90 = 10.40
Total cost = 16,000 * 10.40 = 166,400
Profit / loss = 129,600 - 166,400 = -36,800
As in scenario 1 the profit is higher, thus company should sell the units as scrap