Diamond Garment Manufacturing Company produces a variety of readymade garments for children. The company buys raw cotton and processes it into cotton yarn from which the garments are made. One spindle of cotton yarn is required to produce one garment. The costs and revenues associated with the garments are shown below:

Selling price per garment

$30.00

Cost per garment to manufacture:

Raw materials:

Cotton yarn

$16.00

Buttons, thread, lining

2.00

Total raw materials

18.00

Direct labour

5.80

Manufacturing overhead

8.70

32.50

Manufacturing income (loss) per garment

$ (2.50)

Originally, all of the cotton yarn was used to produce garments. In recent years however, a market has developed for the cotton yarn itself. Current cost and revenue data on the yarn are given below:

Selling price per spindle of yarn

$20.00

Cost per spindle to manufacture:

Raw materials (cotton)

$ 7.00

Direct labour

3.60

Manufacturing overhead

5.40

16.00

Manufacturing income per spindle

$ 4.00

All of the manufacturing overhead costs are fixed and would not be affected even if garments were discontinued. Manufacturing overhead is assigned to products on the basis of 150% of direct labour cost. Materials and direct labour costs are variable.

Required:

What is the incremental contribution margin from further processing the cotton into garments? What is the lowest price that the company should accept for a garment? Explain.