A Company Must Decide Between Scrapping or Rebuilding Units That

question 17

Essay

A company must decide between scrapping or rebuilding units that do not pass inspection. The company has 15,000 such units that cost $6 per unit to manufacture. The units were built to satisfy a special order, which must still be satisfied if the defective units are scrapped. The units can be sold as scrap for $2.50 each or they can be reworked for $4.50 each and sold for the full price of $9.00 each. If the units are sold as scrap, the company will have to build 15,000 replacement units and sell them at the full price.
Required:
(1) What is the net return from selling the units as scrap?
(2) What is the net return from reworking and selling the units?
(3) Should the company sell the units as scrap or rework them?

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Definitions:

Debt-Equity Ratio

A measure of a company's financial leverage, calculated by dividing its total liabilities by its shareholders' equity, indicating the proportion of debt used to finance assets.

Additional Debt

This refers to any extra borrowing taken on by an entity beyond its existing debt obligations.

Operating Capacity

The maximum output that a business can produce using its current resources and facilities without additional investment.

Dividend Payout Ratio

A financial metric that measures the percentage of a company's earnings paid to shareholders in the form of dividends.