Harold Manufacturing produces denim clothing. This year, it produced 5,150 denim

Question

Harold Manufacturing produces denim clothing. This year, it produced 5,150 denim jackets at a manufacturing cost of $42.00 each. These jackets were damaged in the warehouse during storage. Management investigated the matter and identified three alternatives for these jackets.

Jackets can be sold to a secondhand clothing shop for $8.00 each.

Jackets can be disassembled at a cost of $31,400 and sold to a recycler for $11.00 each.

Jackets can be reworked and turned into good jackets. However, with the damage, management estimates it will be able to assemble the good parts of the 5,150 jackets into only 3,030 jackets. The remaining pieces of fabric will be discarded. The cost of reworking the jackets will be $102,100, but the jackets can then be sold for their regular price of $45.00 each.

Required:
1. Calculate the incremental income.

Explanation / Answer

Alternative 1

Income from sale to second hand clothing shop = 5,150 denim jackets*$8.00 = $41,200

Alternative 2

Net income = Revenue - Disassembled Cost

= (5,150 jackets*$11.00) - $31,400

= $56,650 - $31,400 = $25,250

Alternative 3

Net Income = Revenue - Cost of reworking

= (3,030 jackets*$45) - $102,100

= $136,350 - $102,100 = $34,250

The highest income is from alternative 1 (i.e. $41,200) and the next best alternative is alternative 3 with net income of $34,250. The Incremental Income of Alternative 1 over Alternative 3 is $6,950 ($41,200 - $34,250).

Manufacturing cost of $42 per denim jacket is sunk cost and not relevant for the decision.

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