Shareef’s Window Company is in the process of preparing a production cost budget

Question

Shareef’s Window Company is in the process of preparing a production cost budget for August. Actual costs in July for 120 windows were:
Materials cost       $ 4,800
Labor cost                3,000
Rent                        1,500
Depreciation            2,500
Other fixed costs     3,200
Total                  $15,000

The company is currently producing and selling 144 windows annually and each window is sold for $140.00. The company is considering lowering the price to $125.00 for which management estimates this will increase sales to 200 windows. Materials and labor are the only variable costs. Under what situation should the company lower the price of its windows?

A. If total revenue exceeds totals costs under the new pricing
B. If incremental revenue exceeds the old revenue
C. If incremental profit is a positive number
D. If incremental costs decrease

Explanation / Answer

Answer is A) - If if was B, The incremental revenue is actually $125/unit, compared to $140 originally, then we would wrongly NOT lower the price since it makes a profit. - if it was C, the incremental profit per unit under original scenario is $3,600/144 = $25, while for the new scenario is is $4,800/200 = $24 per unit. We know that under the new scenario there is more profit, but here both incremental profits are positive so it is difficult to tell based on this criteria D) Incremental costs have not moved, they are the same per unit. The change is attributed to volume of windows sold, not reduction in costs. Quick calculations: Materials cost per unit = 4,800/120 windows = $40/unit Labor cost per unit = 3,000/120 = $25/unit So total variable costs per windows = 40 + 25 = 65 Total fixed costs = 1,500 + 2,500 + 3,200 = 7,200 If sell 144 windows then the profit is: =[144 x (140 - 65)] - 7,200 = 3,600 If sell 200 windows the profit is: =[200 x (125 - 65)] - 7,200 = 4,800

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