This lecture discusses decision-making in a production company regarding whether to sell a product as is or to process it further for potentially more profit.
Key focus: Determining which option generates the most net profit.
Example 1: Unfinished vs. Finished Tables
Product: Tables by Wood Masters
Initial Costs and Pricing:
Cost of manufacturing unfinished table: $35
Selling price of unfinished table: $50
Selling price of finished table: $60
Costs for Processing Further:
Direct materials increase: $2
Direct labor increase: $4
Variable manufacturing overhead increase: $2.40 (60% of direct labor)
No increase in fixed costs
Profit Analysis:
Additional revenue from finishing: $10
Total increase in costs: $8.40
Additional profit by processing further: $1.60 per table
Decision: Process further to earn additional profit.
Example 2: Multi-Product Case (Cream and Skim Milk)
Scenario 1: Cream to Cottage Cheese
Joint Products: Cream and skim milk from processing raw milk
Initial Costs for Cream:
Joint costs are sunk costs ($9,000 allocated to cream)
Additional cost to process cream to cottage cheese: $10,000
Revenue Analysis:
Sell cream: $19,000 per day
Sell cottage cheese: $27,000 per day
Profit Analysis:
Additional revenue by processing: $8,000
Additional cost: $10,000
Loss by processing further: $2,000
Decision: Sell cream as is to avoid losses.
Scenario 2: Skim Milk to Condensed Milk
Costs and Decisions:
Joint costs for skim milk are sunk costs ($5,000)
Decision does not affect the incurrence of these costs
Key Concepts:
Sunk Costs: Costs that have already been incurred and should not affect future decisions.
Relevant Costs: Only those that differ between decision alternatives should be considered.
Market Considerations: Demand for finished vs. unfinished products can influence decision-making.
Conclusion
The decision to sell or process further should be based on a careful analysis of additional revenues and costs. The goal is to maximize net profit by identifying the most financially advantageous option.