Mahulena Carpet produced 1,200 yards of its economy-grade carpet. In the colorin

Question

Mahulena Carpet produced 1,200 yards of its economy-grade carpet. In the coloring process, there was a pigment defect and the resulting color appeared to be faded. The carpet normally sells for $12 per yard: $6 of variable cost per yard and $4 of fixed cost per yard have been assigned to the carpet. The company realizes that it cannot sell the carpet for $12 per yard, through its normal channels, unless the coloring process is repeated. The incremental cost of the process is $2 per yard. However, Practical Home Solutions is willing to buy the carpet in its current faded condition for $8 per yard.

A: Should Mahulena repeat the coloring process or sell the carpet to Practical Home Solutions?

B: Suppose Practical Home Solutions is willing to buy the carpet for $11 per yard if Mahulena's brand is associated with the carpet by means of a tag indicating the carpet was produced by Mahulena (A highly regarded producer). Would you accept Practical Home Solutions's offer if you were the president of Mahulena?

Explanation / Answer

The fixed and variable costs already incurred are sunk costs and should be disregarded. The only relevant data for section A are the net revenues Mahulena could obtain under the two scenarios. Re-coloring would yield $10 net value per yard ($12 per yard retail cost - $2 per yard cost of re-dying). Selling to Practical Home Solutions would yield only $8 per yard. Recoloring should be selected since it yields an additional $2 per yard in net profit for a total of $2,400 in additional income. B. By accepting Practical Home Solutions' offer, Mahulena would realize $1200 more than it would by re-coloring the carpet ($10 net revenue per yard (see above) vs. $11 under this offer). Mahulena's president must consider whether the potential damage to the brand's reputation is worth the modest increase in net revenue.

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