Austin Wool Products purchases raw wool and processes it into yarn. The spindles

Question

Austin Wool Products purchases raw wool and processes it into yarn. The spindles of yarn can then be sold directly to stores or they can be used by Austin Wool Products to make afghans. Each afghan requires one spindle of yarn. Current cost and revenue data for the spindles of yarn and for the afghans are as follows:

Data for one spindle of yarn:
Selling price $15
Variable production cost $11
Fixed production cost (based on 4,800 spindles of yarn produced) $5

Data for one afghan:
Selling price $35
Production cost per spindle of yarn $16
Variable production cost to process the yarn into an afghan $15
Avoidable fixed production cost to process the yarn into an afghan
(based on 4,800 afghans produced) $11

Each month 4,800 spindles of yarn are produced that can either be sold outright or processed into afghans.

If Austin chooses to produce 4,800 afghans each month, the change in the monthly net operating income as compared to selling 4,800 spindles of yarn is:

$19,200 increase

$19,200 decrease

$-28,800 decrease

$-28,800 increase

Explanation / Answer

incremental revenue = (35-15)*4800 = 96,000 (sell for 35 instead of 15, an extra 20 per unit) incremental costs = (15+11)*4800 = 124,800 (15 more variable and 11 more fixed per unit) incremental revenue - incremental costs = Increase or decrease in income from further processing 96,000 - 124,800 = -28,800 answer: $-28,800 decrease

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