Santiago\'s Salsa is in the process of preparing a production cost budget for Ma

Question

Santiago's Salsa is in the process of preparing a production cost budget for May. Actual costs in April were:


Santiago's Salsa
Production Costs

April 2011

Production


34,300
Jars of Salsa
Ingredient cost (variable) $27,440
Labor cost (variable) 17,150
Rent (fixed) 5,640
Depreciation (fixed) 6,530
Other (fixed)

1,160

Total

$57,920


The company is currently producing and selling 329,400 jars of salsa annually. The jars sell for $5.10 each. The company is considering lowering the price to $4.60. Suppose this action will increase sales to 386,400 jars.

What is the incremental cost associated with producing an extra 57,000 jars of salsa?

What is the incremental revenue associated with the price reduction of $0.50 per jar?

Explanation / Answer

Variable cost per jar is (27440+ 17150)/34300= $1.30. So the incremental cost of the extra 56,000 is 57,000*1.30= 74100. Incremental revenue is (386400*4.60)- (329400* 5.10)= 97500. Since incremental revenue is greater than incremental cost, the price should be lowered. (assuming of course, that the company has the capacity to increase production that much).

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