Custom Frames makes bicycle frames in two processes, tubing and welding. The tubing process has a capacity of 50,000 units per year; welding has a capacity of 75,000 units per year. Cost information follows:
Design of product and process costs ..................................... $110,000
Inspection and testing costs ................................................... 42,500
Scrap costs (all in the tubing dept.) ........................................ 175,000
Demand is very strong. Custom Frames can sell whatever output it can produce for the market price of $50 per frame. Custom Frames can start only 50,000 units into production in the tubing department because of capacity constraints on the tubing machines. The company scraps all defective units produced in the tubing department. Of the 50,000 units started in the tubing operation, 5,000 units (10 percent) are scrapped at the end of the production process. Scrap costs, based on total (fixed and variable) manufacturing costs incurred in the tubing operation, equal $35 per unit as follows:
Direct materials (variable)............................................................................ $18
Direct manufacturing, setup, and materials handling labor (variable).......... 7
Depreciation, rent, and other overhead (fixed)............................................ 10
$35
The ‘‘$10 fixed cost’’ is the portion of the total fixed costs of $500,000 allocated to each unit, whether good or defective. The good units from the tubing department are sent to the welding department. Variable manufacturing costs in the welding department are $3.50 per unit. There is no scrap in the welding department. Therefore, Custom Frame’s total sales quantity equals the tubing department’s output. Custom Frames incurs no other variable costs. Custom Frame’s designers have discovered that using a different type of material in the tubing operation would reduce scrap to zero, but it would increase the variable costs per unit in the tubing department by $2.00. Recall that only 50,000 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 Custom Frames from using the new material and improving quality?
c. Should Custom Frames use the new materials?
d. What other nonfinancial and qualitative factors should Custom Frames consider in making the decision?