Final answer:
The correct choice is C) last year's cost ratio and this year's index because the cost ratio is from when the layer was added and the index reflects current price levels.
Step-by-step explanation:
When using dollar-value LIFO, if the incremental layer was added last year, it should be multiplied by last year's cost ratio and this year's index. This is because the cost ratio determines how much inventory costs have changed up to the point of the latest LIFO layer was added, which would be based on the costs of the prior year when the layer was established. The index for this year reflects the change in price levels up to the current period. Therefore, the correct option is C) last year's cost ratio and this year's index.
To understand how the index is used, consider how price indices are created to calculate an overall average change in relative prices over time. An index number reports the price level, and to establish this, economists choose a base year with an index number equal to 100. Other periods are then compared to the base year to measure changes in prices. The changes in the index number proportionally represent changes in the total dollar cost of purchasing a basket of goods, allowing for the calculation of the inflation rate using the percentage change formula. Thus, the price index plays a crucial role in adjusting the LIFO layers for inflation.