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)	$(37,170)	$(103,770)
Fixed costs	(32,000)	(12,400)	(24,780)	(69,180)
Total cost of goods sold	$(80,000)	$(31,000)	$(61,950)	$(172,950)
Gross profit	$120,000	$124,000	$115,050	$359,050
Operating expenses:
Variable expenses	$(5,000)	$(7,750)	$(53,080)	$(65,830)
Fixed expenses	(89,000)	(77,500)	(106,200)	(272,700)
Total operating expenses	$(94,000)	$(85,250)	$(159,280)	$(338,530)
Operating income (loss)	$26,000	$38,750	$(44,230)	$20,520

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?

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
Contribution margin per bottleneck hour
Differential revenue is more than differential cost
Supplier price is less than WoolCorp’s variable cost per unit
Sunk costs
Robinson-Patman Act

Answer 1

Differential Analysis

Continue Rug Yarn (Alternative 1) or Discontinue Rug Yarn (Alternative 2)

December 31, 20Y8

	Continue Rug Yarn	Discontinue Rug Yarn	Differential effect on Income
	Alternative 1	Alternative 2	Alternative 2
Revenues	$ 1,77,000.00	$                   -	$        -1,77,000.00
Costs:
Variable	$    -90,250.00	$                   -	$            90,250.00
Fixed	$ -1,30,980.00	$ -1,30,980.00	$                         -
Income (loss)	$    -44,230.00	$ -1,30,980.00	$           -86,750.00
Workings:
Variable	$     90,250.00	=37170+53080
Fixed	$ 1,30,980.00	=24780+106200

1.  WoolCorp should continue (Alternative 1) the rug yarn product line.

If WoolCorp discontinue the Rug Yarn, there will be increase in loss by $86750.

2.

	Lease or Sell	Sell or Process Further	Special Price Order	Make or Buy	Continue or Discontinue	Production Bottleneck	Not Important
Impact on regular prices	√	√	√	√	√	√
Contribution margin per bottleneck hour	√	√	√		√	√
Differential revenue is more than differential cost	√	√	√		√	√
Supplier price is less than WoolCorp’s variable cost per unit				√		√
Sunk costs							√
Robinson-Patman Act							√