Question

a company has produced 1,000 defective units at the cost of $6,000, they have the choice of either selling those defective units as scrap for $4.00 per unit. alternatively, it could rework them with incremental costs of $1.00 per unit for materials, $2.00 per unit for labor, and $1.50 per unit for overhead, and then sell the rebuilt units for $8.00 each. should the company scarp or rework? (ignore opportunity costs)

Answer 1

Since scrapping the problematic units brings in more money than selling them after rebuilding, the corporation should choose to do so.

Define Contribution Margin per unit.

It stands for the portion of Sales that is not covered by variable costs. It contributes to the fixed cost coverage.

Contribution when the units are sold:

Total contribution = (Number of units x selling price as scrap)

                              = 1000 x 4

                              = $4000

That is,  the company would generate contribution of 4,000 if the units were sold as scrap.

Contribution per unit after rebuilding = $8 - ($1 + $2 + $ 1.5) = $3.5

Total contribution from selling after rebuilding = 1000 x $3.5 = $3500

The difference between the contributions from selling as scrap and selling after rebuilding:

= (contribution from selling as scrap - Contribution from selling after rebuilding)

= 4000 - 3500

= $500

That is, the contribution from selling as scrap is $500 more than that from selling after rebuilding.

Therefore, Since scrapping the problematic units brings in more money than selling them after rebuilding, the corporation should choose to do so.

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