Chen Products makes cases for portable music players in two processes, cutting and sewing. The cutting process has a capacity of 100,000 units per year; sewing has a capacity of 200,000 units per year. Costs of quality information follow:
Design of product and process costs ................................................ $100,000
Inspection and testing costs ............................................................. 50,000
Scrap costs (all in the cutting dept.) ................................................ 155,000
Demand is very strong. At a sales price of $20 per case, the company can sell whatever output it can produce. Chen Products can start only 100,000 units into production in the cutting department because of capacity constraints. All defective units produced in the cutting department are scrapped. Of the 100,000 units started in the cutting operation, 15,000 units are scrapped. Units are not discovered to be defective until the end of the production in the cutting department. Unit costs, based on total (fixed and variable) manufacturing costs incurred through the cutting operation, equal $11 as follows:
Direct materials (variable) ......................................................................... $5
Direct manufacturing, setup, and materials handling labor (variable)......... 2
Depreciation, rent, and other overhead (fixed)............................................ 4
$11
The fixed cost of $4 per unit is the allocated fixed costs of the department to each unit, whether good or defective. The total fixed costs in the cutting department are $400,000. The good units from the cutting department are sent to the sewing department. Variable manufacturing costs in the sewing department are $2 per unit. There is no scrap in the sewing department. Therefore, the company’s total sales quantity equals the sewing department’s good output. The company incurs no other variable costs. The company’s designers have discovered that adding a different type of material to the existing direct materials would reduce scrap to zero, but it would increase the variable costs per unit in the cutting department by $1.20. Recall that only 100,000 units can be started each year.
a. What is the additional direct materials cost of implementing the new method?
b. What is the additional benefit to the company from using the new material and improving quality?
c. Should Chen Products use the new materials?
d. What other nonfinancial and qualitative factors should management of Chen Products consider in making the decision?