A company has 5,000 obsolete toys in inventory at a production cost of $10 each. If the toys were remade for $ 3 each, they could sell for $ 5 each. If the toys are thrown away, they can be sold for $ 2.5 each. Which alternative is more desirable (rework or scrap) and what is the total benefit amount of this alternative?
Scrap, $2,500
Analyzing Obsolete Inventory Decision: Rework vs. Scrap
When a company has obsolete inventory, it faces a decision on what to do with it. The options usually involve further processing (rework) or selling it as scrap. The key is to identify the relevant costs and benefits for each alternative and choose the one that yields the highest net benefit.
Understanding Sunk Costs
The original production cost of the obsolete toys ($10 each) is a sunk cost. A sunk cost is a cost that has already been incurred and cannot be recovered. Sunk costs are irrelevant to future decisions and should be ignored when evaluating alternatives like rework or scrap.
Evaluating the Rework Alternative
Under the rework alternative, the company incurs additional costs to make the toys sellable at a higher price.
- Number of toys: 5,000
- Rework cost per toy: $3
- Selling price after rework per toy: $5
Let's calculate the total revenue and total rework cost for this option:
Total Revenue (Rework) = Number of toys $\times$ Selling price after rework per toy
Total Revenue (Rework) = $5,000 \times \$5 = \$25,000$
Total Rework Cost = Number of toys $\times$ Rework cost per toy
Total Rework Cost = $5,000 \times \$3 = \$15,000$
The net benefit from the rework alternative is the difference between the total revenue and the total rework cost:
Net Benefit (Rework) = Total Revenue (Rework) - Total Rework Cost
Net Benefit (Rework) = $\$25,000 - \$15,000 = \$10,000$
Evaluating the Scrap Alternative
Under the scrap alternative, the company sells the obsolete toys in their current state.
- Number of toys: 5,000
- Selling price if scrapped per toy: $2.5
Let's calculate the total revenue from scrapping the toys. We assume there are no additional costs associated with scrapping and selling.
Total Revenue (Scrap) = Number of toys $\times$ Selling price if scrapped per toy
Total Revenue (Scrap) = $5,000 \times \$2.5 = \$12,500$
The net benefit from the scrap alternative is simply the total revenue from scrapping, as there are no relevant costs associated with this option (assuming no disposal costs beyond the revenue received).
Net Benefit (Scrap) = Total Revenue (Scrap)
Net Benefit (Scrap) = $\$12,500$
Comparing Alternatives: Rework vs. Scrap
Now, let's compare the net benefits calculated for each alternative:
- Net Benefit (Rework): $10,000
- Net Benefit (Scrap): $12,500
Comparing these amounts, the scrap alternative ($\$12,500$) provides a higher net benefit than the rework alternative ($\$10,000$). Therefore, the scrap alternative is more desirable.
| Alternative | Total Revenue | Relevant Costs | Net Benefit |
|---|---|---|---|
| Rework | $25,000 | $15,000 | $10,000 |
| Scrap | $12,500 | $0 | $12,500 |
Calculating the Total Benefit Amount
The question asks for the total benefit amount of the more desirable alternative. Based on the comparison, the scrap alternative is more desirable with a net benefit of $12,500. However, comparing this with the provided options, it appears the question asks for the *additional* benefit gained by choosing the more desirable alternative over the other option.
Difference in Net Benefit = Net Benefit (Scrap) - Net Benefit (Rework)
Difference in Net Benefit = $\$12,500 - \$10,000 = \$2,500$
This $\$2,500$ represents the additional benefit obtained by choosing to scrap the toys instead of reworking them.
Conclusion
The more desirable alternative is to scrap the obsolete toys. The total benefit amount, interpreted as the additional benefit compared to the rework option, is $2,500.
Important Questions from Project Planning
Pick up the correct statement from the following.
Miscellaneous expenses such as office expenses, stationery, postal expenses, etc., falls under _______.
Which of the following phases does NOT come under the project management stages?
The maximum amount of time that an activity can be delayed without extending the completion time of the overall project is called:
Branch manager is a part of:
