Sell or Process Further Decision
The Scottie Sweater Company produces sweaters under the Scottie label. The company buys raw wool
and processes it into wool yarn from which the sweaters are woven. One spindle of wool yarn is required
to produce one sweater. The costs and revenues associated with the sweaters are given below:
Originally, all of the wool yarn was used to produce sweaters, but in recent years a market has developed
for the wool yarn itself. The yarn is purchased by other companies for use in production of wool blankets
and other wool products. Since the development of the market for the wool yarn, a continuing dispute has
existed in the Scottie Sweater Company as to whether the yarn should be sold simply as yarn or
processed into sweaters. Current cost and revenue data on the yarn are given below:
The market for sweaters is temporarily depressed, due to unusually warm weather in the western states
where the sweaters are sold. This has made it necessary for the company to discount the selling price of
the sweaters to $30 from the normal $40 price. Since the market for wool yarn has remained strong, the
dispute has again surfaced over whether the yarn should be sold outright rather than processed into
sweaters. The sales manager thinks that the production of sweaters should be discontinued; she is upset
about having to sell sweaters at a $2.50 loss when the yarn could be sold for a $4.00 profit. However, the
production superintendent does not want to close down a large portion of the factory. He argues that the
company is in the sweater business, not the yarn business, and that the company should focus on its core
strength.
All of the manufacturing overhead costs are fixed and would not be affected even if sweaters were
discontinued. Manufacturing overhead is assigned to products on the basis of 150% of direct labor cost.
Materials and direct labor costs are variable.
Required:
1. Would you recommend that the wool yarn be sold outright or processed into sweaters? Support your
answer with appropriate computations and explain your reasoning.
2. What is the lowest price that the company should accept for a sweater? Support your answer with
appropriate computations and explain your reasoning