Milford Corporation has in stock 16,100 kilograms of material R that it bought five years ago for $5.75 per kilogram.This raw material was purchased to use in a product line that has been discontinued.Material R can be sold as is for scrap for $3.91 per kilogram.An alternative would be to use material R in one of the company's current products, S88Y, which currently requires 2 kilograms of a raw material that is available for $7.60 per kilogram.Material R can be modified at a cost of $0.77 per kilogram so that it can be used as a substitute for this material in the production of product S88Y.However, after modification, 4 kilograms of material R is required for every unit of product S88Y that is produced.Milford Corporation has now received a request from a company that could use material R in its production process.Assuming that Milford Corporation could use all of its stock of material R to make product S88Y or the company could sell all of its stock of the material at the current scrap price of $3.91 per kilogram, what is the minimum acceptable selling price of material R to the company that could use material R in its own production process?

A) $0.88 per kg
B) $3.03 per kg
C) $4.57 per kg
D) $3.91 per kg

Question

Devon Amerud · Accepted Answer

Final Answer : B, Explanation :  If Milford Corporation sells the material R as scrap, it will receive $3.91 per kilogram. However, if it modifies the material and uses it as a substitute for the current raw material used in S88Y, the cost will be $5.75 + $0.77 = $6.52 per kilogram.The cost of using the current raw material in S88Y is $7.60 per kilogram, whereas the cost of using the modified material R in S88Y is $6.52/2 + 2*$3.91 = $7.47 per kilogram.Therefore, it is more profitable to use the modified material R in S88Y than to sell it as scrap. Milford Corporation can use the entire stock of material R to produce S88Y if the selling price is at least $7.47 per kilogram. Since the material R costs $5.75 per kilogram, the minimum acceptable selling price is $7.47 - $5.75 = $1.72 per kilogram.However, we need to consider that after modification, 4 kilograms of material R is required for every unit of product S88Y that is produced. This means that Milford Corporation can produce 16,100/4 = 4,025 units of S88Y. Therefore, the total revenue from selling S88Y will be $7.47*2*4,025 = $60,151.If the company sells the entire stock of material R as scrap, it will receive $3.91 per kilogram, which is a total revenue of $3.91*16,100 = $62,831.Since the total revenue from selling the material R as scrap is higher than the revenue from producing and selling S88Y, Milford Corporation should sell the entire stock of material R as scrap.The minimum acceptable selling price is therefore the scrap price of $3.91 per kilogram, answer choice (B).   The value of using material L to produce R is greater than its scrap value, so the company would be giving up benefits of $3.03 per kilogram if it were to sell material L.Therefore, the minimum acceptable price is $3.03 per kilogram.

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