The Scottie Sweater Company produces sweaters under the \"Scottie\' label. The c

Question

The Scottie Sweater Company produces sweaters under the "Scottie' label. The company buys raw wool and processes it into wool yarn from which the sweaters are woven. One spindle of wool yarn is required to produce one sweater. The costs and revenues associated with the sweaters are given below: Per Sweater 29.00 Selling price Cost to manufacture: Raw materials: $2.00 15.00 17.00 6.20 Buttons, thread, lining Wool yarrn Total raw materials Direct labor 32.50 $ (3.50) Manufacturing profit (loss) Originally, all of the wool yarn was used to produce sweaters, but in recent years a market has developed for the wool yarn itself. The yam is purchased by other companies for use in production of wool blankets and other wool products. Since the development of the market for the wool yarn, a continuing dispute has existed in the Scottie Sweater Company as to whether the yarn should be sold simply as yarn or processed into sweaters. Current cost and revenue data on the yarn are given below Per Spindle of Yarn Selling price Cost to manufacture: S 19.00 Raw materials (raw wool) Direct labor S6.00 2.40 6.60 Manufacturing overhead Manufacturing profit S 4.00 The market for sweaters is temporarily depressed, due to unusually warm weather in the western states where the sweaters are sold. This has made it necessary for the company to discount the selling price of the sweaters to $29 from the normal $39 price. Since the market for wool yam has remained strong, the dispute has again surfaced over whether the yarn should be sold outright rather than processed into sweaters. The sales manager thinks that the production of sweaters should be discontinued; she is upset about having to sell sweaters at a $3.50 loss when the yarn could be sold for a $4.00 profit. However, the production superintendent does not want to close down a large portion of the factory. He argues that the company is in the sweater business, not the yarn business, and that the company should focus on its core strength. All of the manufacturing overhead costs are fixed and would not be affected even if sweaters were discontinued. Manufacturing overhead is assigned to products on the basis of 150% of direct labor cost. Materials and direct labor costs are variable Required 1-a. What would be the increase or decrease in the unit contribution margin if the yam is further processed into sweaters? (Round your answer to 2 decimal places.)

Explanation / Answer

Solution 1a:

Increase in unit contribution margin if yarn is further processed in to sweaters = $12.40 - $10.60 = $1.80

Solution 1b:

As unit contribution margin for sweater is higher than wool yarn therefore yarn should be further processed in to sweaters.

Solution 2:

The lowest price company should accept for a sweater is the price in which contribution margin per unit for sweater of wool yarn will be the same. Therefore lowest acceptable price = $29 - $1.80 = $27.20

Computation of unit contribution margin of sweater and wool yarn - Scottie Sweater Company Particulars Sweater Wool Yarn Selling price $29.00 $19.00 Variable cost: Button, thread, lining $2.00 $0.00 Raw material (Raw Wool) $6.00 $6.00 Direct labor (Wool yarn) $2.40 $2.40 Direct labor - Further processing $6.20 $0.00 Unit contribution margin $12.40 $10.60

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