Question

The Scottie Sweater Company produces sweaters under the·Scottie' label. The company buys raw wool and processes it into wool yam 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 $ 37.00 Selling price Cost to manufacture Raw materials: Buttons, thread, lining Wool yarn Total raw materials Direct labor Manufacturing overhead S 2.00 16.00 18.00 8.60 12.90 39.50 $ (2.50) 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 yarn 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 yam 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 24.00 Raw materials (raw wool) Direct labor Manufacturing overhead S10.00 2.40 3.60 16.00 $ 8.00 Manufacturing profit The market for sweaters is temporanly 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 $37.00 from the normal S47.00 price. Since the market for wool yarn 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 $2.50 loss when the yarn could be sold for a $8.00 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 the company should focus on its core strength All of the manufactunng overhead costs are fixed and would not be affected even if sweaters were discontinued. Manufactunng overhead is assigned to products on the basis of 150% of direct labor cost. Materials and direct labor costs are variable

Answer 1

1 a)
	Per Sweater ($)
Selling price			37
Less: Variable Cost to manufacture:
Raw materials:
Buttons, thread, lining	2
Wool yarn	12.4	(Note 1)
Total raw materials		14.4
Direct labor		8.6	23
Contribution			14
	Per Spindle
	of Yarn ($)
Selling price		24
Less: Variable Cost to manufacture:
Raw materials (raw wool)	10
Direct labor	2.4
		12.4
Contribution		11.6
Note 1) the variable cost of wool yarn has been taken to compute the contribution of the sweater. This is because the entire manufacturing cost is sunk cost and would not change irrespective of the continuance of production or not.
Based on the above calculation, it is evident that the if the yarn is further processed into sweater, there will be an increase in contribution by $14 - $11.60 = $2.40, even when the selling price has been reduced from normal $47 to $37.
1-b)
the yarn should be further processed into sweaters.
2)
If the company produces sweater, then it will be loosing the opportunity of making contribution of $ 11.60 per yarn. So the lowest price that should be accepted by the company for a sweater
= variable cost of making the sweater + contribution foregone for not selling yarn
$23.00 + $11.60 = $34.60