Question

A company has the choice of either selling 1,000 defective units as scrap or rebuilding them.

The company could sell the defective units as they are for $4.00 per unit.

Alternatively, it could rebuild 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.

If the company rebuilds the units, what is the impact on income?

Answer 1

Answer:

It will be better for the company to sell the defective units as they are.

Explanation:

If company sells the defective items as scrap:

Profit = Revenue - Cost

         = (1,000 × $4 per unit) - $0

         = $4,000

If the company rebuilds the units:

Profit:

= Revenue - cost for materials - Labor cost - overhead

= (1,000 × $8 per unit) - (1,000 × $1 per unit) - (1,000 × $2 per unit) - (1,000 × $1.50 per unit)

= $8,000 - $1,000 - $2,000 - $1,500

= $3,500

It is clear from the above calculations that if the company rebuilds the units, then there is a profit of $3,500 which has a positive impact on income and on the other hand, if the company sells the defective items as scrap then there is a profit of $4,000 which also has a positive impact on income.

Hence, it will be better for the company to sell the defective units as scrap because this option will give a larger profit than the other option.