Question

Mastery Problem: Differential Analysis and Product Pricing

WoolCorp

WoolCorp buys sheep’s wool from farmers. The company began operations in January of this year, and is making decisions on product offerings, pricing, and vendors. The company is also examining its method of assigning overhead to products. You’ve just been hired as a production manager at WoolCorp.

Currently WoolCorp makes three products: (1) raw, clean wool to be used as stuffing or insulation; (2) wool yarn for use in the textile industry, and (3) extra-thick yarn for use in rugs.

Upper management would like your recommendations regarding a production decision regarding their current and proposed product lines.

Continue/Discontinue

For the past year, WoolCorp has experimented with its third product, extra-thick rug yarn. The company wishes to consider whether to continue or discontinue manufacturing and selling this product. You decide to prepare a differential analysis of the income related to all three products. To begin your analysis, you review the following condensed income statement. Then scroll down to complete the differential analysis.

WoolCorp Condensed Income Statement For the Year Ended December 31, 20Y8
	Raw Wool			Wool Yarn			Rug Yarn			Total Company
Sales		$200,000			$155,000			$177,000		$532,000
Costs of goods sold:
Variable costs	$(48,000)	$(18,600)	$(37,180)	$(103,780)
Fixed costs	(32,000)	(12,400)	(24,780)	(69,180)
Total cost of goods sold	$(80,000)	$(31,000)	$(61,960)	$(172,960)
Gross profit	$120,000	$124,000	$115,040	$359,040
Operating expenses:
Variable expenses	$(5,000)	$(7,750)	$(53,110)	$(65,860)
Fixed expenses	(89,000)	(78,000)	(106,200)	(273,200)
Total operating expenses	$(94,000)	$(85,750)	$(159,310)	$(339,060)
Operating income (loss)	$26,000	$38,250	$(44,270)	$19,980

Complete the following table using the data in the preceding income statement to compare the effects of dropping the rug yarn line of products. If required, use a minus sign to indicate a loss.

Differential Analysis
Continue Rug Yarn (Alternative 1) or Discontinue Rug Yarn (Alternative 2)
December 31, 20Y8
	Continue Rug Yarn (Alternative 1)	Discontinue Rug Yarn (Alternative 2)	Differential Effects (Alternative 2)
Revenues	$	$	$
Costs:
Variable
Fixed
Profit (loss)	$	$	$

Final Questions

Answer the following question (1), then fill in table (2).

1. After reviewing your work on the Continue/Discontinue panel, should WoolCorp continue (Alternative 1) or discontinue (Alternative 2) the rug yarn product line?

Continue (Alternative 1).

2. The following table shows several business decisions that might need to be made across the top row. Along the left-hand column, there are important factors to consider.

Select the factor(s) that are important to the decision. Select all that apply. If the factor is not important to any of the decisions, select "yes" on the "Not Important" dropdown, otherwise select "no".

	Lease or Sell	Sell or Process Further	Special Price Order	Make or Buy	Continue or Discontinue	Production Bottleneck	Not Important
Impact on regular prices	Yes	Yes	Yes	Yes	Yes	Yes	No
Contribution margin per bottleneck hour	Yes	Yes	Yes	No	Yes	Yes	No
Differential revenue is more than differential cost	Yes	Yes	Yes	Yes	No	Yes	No
Supplier price is less than WoolCorp’s variable cost per unit	No	No	No	Yes	No	Yes	No
Sunk costs	No	No	No	No	No	No	Yes
Robinson-Patman Act	No	No	No	No	No	No	Yes

Answer 1

complete the differential analysis.

WoolCorp Condensed Income Statement For the Year Ended December 31, 20Y8
	Raw Wool	Wool Yarn	Rug Yarn	Total Company
Sales	$200,000	$155,000	$177,000	$532,000
Costs of goods sold:
Variable costs	$(48,000)	$(18,600)	$(37,180)	$(103,780)
Fixed costs	(32,000)	(12,400)	(24,780)	(69,180)
Total cost of goods sold	$(80,000)	$(31,000)	$(61,960)	$(172,960)
Gross profit	$120,000	$124,000	$115,040	$359,040
Operating expenses:
Variable expenses	$(5,000)	$(7,750)	$(53,110)	$(65,860)
Fixed expenses	(89,000)	(78,000)	(106,200)	(273,200)
Total operating expenses	$(94,000)	$(85,750)	$(159,310)	$(339,060)
Operating income (loss)	$26,000	$38,250	$(44,270)	$19,980

.

Complete the following table using the data in the preceding income statement to compare the effects of dropping the rug yarn line of products. If required, use a minus sign to indicate a loss.

Differential Analysis
Continue Rug Yarn (Alternative 1) or Discontinue Rug Yarn (Alternative 2)
December 31, 20Y8
	Continue Rug Yarn (Alternative 1)	Discontinue Rug Yarn (Alternative 2)	Differential Effects (Alternative 2)
Revenues	532000	355000	-177000
Costs:
Variable	169640	79350	90290
Fixed	342380	342380	0**
Profit (loss)	19980	-66730	-86710

Final Questions

Answer the following question (1), then fill in table (2).

1. After reviewing your work on the Continue/Discontinue panel, should WoolCorp continue (Alternative 1) or discontinue (Alternative 2) the rug yarn product line?

.

>>continue the product line of extra-thick yarn for use in rugs because not doing so (discontinuing it) would mean bigger losses. If we discontinue the line we incur loss of $66730 by reducing a total decrease in profit of $86710

So, continue the Alternative 1

.

**Please note that the extra-thick yarn for rugs line carry a total of $130,980 fixed costs (fixed cost of goods sold of $24780 + fixed operating expenses of $106200 ), this means that even if the Management decides to discontinue producing the line, the company would still incur this fixed costs which would be eventually carried over by the two remaining lines.

.

2. The following table shows several business decisions that might need to be made across the top row. Along the left-hand column, there are important factors to consider.

Select the factor(s) that are important to the decision. Select all that apply. If the factor is not important to any of the decisions, select "yes" on the "Not Important" dropdown, otherwise select "no".

	Lease or Sell	Sell or Process Further	Special Price Order	Make or Buy	Continue or Discontinue	Production Bottleneck	Not Important
Impact on regular prices	Yes	Yes	Yes	Yes	Yes	Yes	No
Contribution margin per bottleneck hour	Yes	Yes	Yes	No	Yes	Yes	No
Differential revenue is more than differential cost	Yes	Yes	Yes	Yes	No	Yes	No
Supplier price is less than WoolCorp’s variable cost per unit	No	No	No	Yes	No	Yes	No
Sunk costs	No	No	No	No	No	No	Yes
Robinson- Patman Act	No	No	No	No	No	No	Yes