Milford Corporation has in stock 16,100 kilograms of material R that it bought five years ago for $5.75 per kilogram. This raw material was purchased to use in a product line that has been discontinued. Material R can be sold as is for scrap for $3.91 per kilogram. An alternative would be to use material R in one of the company's current products, S88Y, which currently requires 2 kilograms of a raw material that is available for $7.60 per kilogram. Material R can be modified at a cost of $0.77 per kilogram so that it can be used as a substitute for this material in the production of product S88Y. However, after modification, 4 kilograms of material R is required for every unit of product S88Y that is produced. Milford Corporation has now received a request from a company that could use material R in its production process. Assuming that Milford Corporation could use all of its stock of material R to make product S88Y or the company could sell all of its stock of the material at the current scrap price of $3.91 per kilogram, what is the minimum acceptable selling price of material R to the company that could use material R in its own production process? (Round your intermediate calculations to 2 decimal places.)
A) $0.88 per kilogram
B) $3.03 per kilogram
C) $4.57 per kilogram
D) $3.91 per kilogram

Question

Quizplus · Accepted Answer

If Milford Corporation sells the material R as scrap, it will receive $3.91 per kilogram for a total revenue of:
$3.91/kg x 16,100 kg = $63,031

If Milford Corporation modifies the material R and uses it to make product S88Y, it can save on the cost of purchasing the original raw material that is currently used for the product. The cost of modification is $0.77 per kg, so the total cost of using material R in product S88Y would be:
$5.75/kg + $0.77/kg = $6.52/kg

Milford Corporation would need 4 kg of modified material R to make one unit of product S88Y. Therefore, 1 kg of modified material R can produce 1/4 = 0.25 units of product S88Y. The cost of 1 kg of modified material R can be allocated to 0.25 units of product S88Y. Therefore, the cost of material R per unit of product S88Y would be:
$6.52/kg ÷ 0.25 = $26.08/unit

The current cost of the original raw material used in product S88Y is $7.60/kg. Therefore, Milford Corporation can save $7.60/kg - $6.52/kg = $1.08/kg by using modified material R. So, the cost of using modified material R in product S88Y would be:
$6.52/kg - $1.08/kg = $5.44/kg

If Milford Corporation sells material R to the other company, it should charge a price that is higher than the scrap price of $3.91/kg but lower than the cost of using the material in product S88Y, which is $5.44/kg. Therefore, the minimum acceptable selling price of material R to the company that could use the material in its own production process is:
($5.44/kg + $3.91/kg) ÷ 2 = $4.18/kg

However, this price does not take into account the cost of modifying the material R, which would be incurred regardless of whether Milford Corporation sells the material as scrap or uses it in product S88Y. Therefore, the minimum acceptable selling price should be higher than $4.18/kg. The only option that meets this requirement is B) $3.03 per kilogram.

Milford Corporation Has in Stock 16,100 Kilograms of Material R