Metallic, Inc., produces metal gates in two processes: bending, in which metal is bent to the correct shape, and welding, in which the bent metal pieces are welded into gates. The bending process has a capacity of 10,000 units per year; welding has a capacity of 14,000 units per year. Demand is strong. At a sales price of $500 per unit, the company can sell whatever output it can produce.

Metallic can start only 10,000 units into production in the Bending Department because of capacity constraints. At present, 1,500 units are found to be defective in the Bending Department each year. Defective units are not detected until the end of production in the Bending Department. At that point, the 1,500 defective units are scrapped. Unit costs in the Bending Department for both good and defective units equal $250 per unit, including an allocation 

of the total fixed manufacturing costs of $750,000 per year to units.

 

Direct materials (variable)

$ 125

Direct manufacturing, setup, and materials handling labor (variable)

50

Depreciation, rent, and other overhead (fixed)

75

Total unit cost

$250

The fixed cost of $75 per unit is the allocation of total fixed costs of the Bending Department to each unit, whether good or defective. (The total fixed costs are the same whether the units produced in the Bending Department are good or defective.)

The good units from the Bending Department are sent to the Welding Department. Variable manufacturing costs in the Welding Department are $75 per unit and fixed manufacturing costs are $500,000 per year. There is no scrap in the Welding Department. Therefore, the company's total sales quantity equals the Bending Department's good output. The company incurs no other variable costs.

The company's designers have discovered that, by using a new type of direct material, the company could reduce scrap in the Bending Department from 1,500 units to 500 units. Using the new material would increase the direct 

materials costs to $180 per unit in the Bending Department for all 10,000 units. Recall that only 10,000 units can be started each year.

 

Required

a.Should Metallic use the new material and improve quality? Assume that inspection and testing costs of $120,000 per year will be reduced by $20,000 with the new materials. Fixed costs in the Bending Department will remain the same whether 8,500 or 9,500 units are produced.

b.What other nonfinancial and qualitative factors should management of Metallic consider in making the decision?