Please take a look at the question below and the answer explanation:
A manufacturing company’s primary goals include product quality and customer satisfaction. The company sells a product, for which the market demand is strong, for $50 per unit. Due to the capacity constraints in the Production Department, only 300,000 units can be produced per year. The current defective rate is 12% (i.e., of the 300,000 units produced, only 264,000 units are sold and 36,000 units are scrapped). There is no revenue recovery when defective units are scrapped. The full manufacturing cost of a unit is $29.50, including
Direct material $17.50
Direct labor 4.00
Fixed manufacturing overhead 8.00
The company’s designers have estimated that the defective rate can be reduced to 2% by using a different direct material. However, this will increase the direct material cost by $2.50 per unit to $20 per unit. The net benefit of using the new material to manufacture the product would be
$1,425,000
$ 120,000
$ (120,000)
$ 750,000
And here's the answer explanation:
Answer: 750,000. This solution includes the variable cost of the 300,000 units produced as well as the $2.50 incremental variable cost for the new direct material. See supporting calculations.
Supporting calculations
Original:
Units produced $300,000
Good units (88%) 264,000
Revenue
264,000 × $50 13,200,000
Production department costs
264,000 × $29.50
264,000 × $21.50
300,000 × $21.50 (6,450,000)
Margin 6,750,000
New material:
Units produced 300,000
Good units (98%) 294,000
Revenue
294,000 × $50 14,700,000
Production department costs
294,000 × $29.50
300,000 × $21.50 (6,450,000)
300,000 × $ 2.50
294,000 × $21.50
294,000 × $ 2.50
30,000 × $ 2.50
Margin 7,500,000
Increase (decrease) $750,000
MY QUESTION IS:
Why are they using the same Costs of 21.50 used in the original scenario? If the Direct Materials increase by $2.50 would that not increase the product cost to $24? There is something I'm missing here. Any help would be greatly appreciated.