Question

Fiesta Shirts produces two types of t-shirts crew neck and y-neck. The variable cost of producing each crew neck shirt is $4.25, and $4.50 per shirt for each v-neck. Fixed costs per shirt are $1.50 per shirt when the production level is 12,000 of both types of shirts. The fixed cost is for factory costs including rent, depreciation, and insurance. Crew necks are currently sold for $7.00 each, while v-necks are sold for $8.00 each. During the past year, the company has sold 12,000 of each type of shirt. The company estimates it can sell 14,000 crew neck shirts during the upcoming year if it reduces the selling price to $6.50 per shirt.

a. Prepare the incremental analysis (calculate incremental revenue, cost and profit) to evaluate this situation for the coming year.

Answer 1

The incremental analysis provides insights into the financial impact of reducing the selling price of crew neck shirts.

Incremental Revenue: $1,000 (14,000 crew neck shirts * ($7.00 - $6.50)) Incremental Cost: $0 (No change in variable or fixed costs) Incremental Profit: $1,000 (Incremental Revenue - Incremental Cost)

Incremental Revenue:

• Current revenue from crew neck shirts: 12000 shirts * $7.00/shirt
• Potential additional revenue from increased sales of crew neck shirts: 2,000 shirts×($6.50−$7.00)/shirt

Total Incremental Revenue = Current Revenue + Additional Revenue

Incremental Variable Cost:

• Variable cost per crew neck shirt: $4.25
• Variable cost per v-neck shirt: $4.50
• Current variable cost for crew neck shirts: 12,000 shirts×$4.25/shirt
• Additional variable cost for potential additional crew neck shirts: 2,000 shirts×$4.25/shirt

Total Incremental Variable Cost=Current Variable Cost + Additional Variable Cost

Incremental Fixed Cost:

• Fixed cost per shirt: $1.50
• Total fixed cost for current production: 12000 shirts * $1.50/shirt
• Total fixed cost for potential additional crew neck shirts: 2000 shirts × $1.50/shirt

Total Incremental Fixed Cost=Current Fixed Cost + Additional Fixed Cost

Incremental Profit = Total Incremental Revenue−Total Incremental Variable Cost−Total Incremental Fixed Cost

Now, let's plug in the values and calculate the incremental analysis. Note that I'll assume no change in the sales price or fixed costs for v-neck shirts.

Current Revenue=12,000 shirts×$7.00/shirt=$84,000

Additional Revenue=2,000 shirts×($6.50−$7.00)/shirt=$−1,000

Total Incremental Revenue=$84,000+(−$1,000)=$83,000

Current Variable Cost=12,000 shirts×$4.25/shirt=$51,000

Additional Variable Cost=2,000 shirts×$4.25/shirt=$8,500

Total Incremental Variable Cost=$51,000+$8,500=$59,500

Current Fixed Cost=12,000 shirts×$1.50/shirt=$18,000

Additional Fixed Cost=2,000 shirts×$1.50/shirt=$3,000

Total Incremental Fixed Cost =$18,000+$3,000 = $21,000

Incremental Profit= $83,000−$59,500−$21,000 = $2,500

Therefore, the incremental profit for the upcoming year, considering the potential reduction in the selling price of crew neck shirts, is $2,500.