E7-9 Lori Luthen recently opened her own basketweaving studio. She sells finished baskets in addition to the raw materials needed by customers to weave baskets of their own. Lori has put together a variety of raw material kits, each including materials at various stages of completion. Unfortunately, owing to space limitations, Lori is unable to carry all varieties of kits originally assembled and must choose between two basic packages.
The basic introductory kit includes undyed, uncut reeds (with dye included) for weav- ing one basket. This basic package costs Lori $14 and sells for $28. The second kit, called Stage 2, includes cut reeds that have already been dyed. With this kit the customer need only soak the reeds and weave the basket. Lori is able to produce the second kit by using the basic materials included in the first kit and adding one hour of her own time, which she values at $20 per hour. Because she is more efficient at cutting and dying reeds than her average customer, Lori is able to make two kits of the dyed reeds, in one hour, from one kit of undyed reeds. The Stage 2 kit sells for $35.
Instructions
Determine whether Lori’s basketweaving shop should carry the basic introductory kit with undyed and uncut reeds or the Stage 2 kit with reeds already dyed and cut. Prepare an incremental analysis to support your answer.
The Correct Answer and Explanation is :
To determine whether Lori should carry the basic introductory kit or the Stage 2 kit, we can perform an incremental analysis focusing on the relevant costs and revenues associated with each option.
Basic Introductory Kit:
- Cost to Lori: $14 per kit
- Selling Price: $28 per kit
- Profit per Kit: $28 (selling price) – $14 (cost) = $14
Stage 2 Kit:
- Cost of Basic Materials: $14 per kit
- Lori’s Time: 1 hour valued at $20 per hour
- Kits Produced per Hour: 2 Stage 2 kits from one basic kit
- Total Cost for Two Stage 2 Kits: $14 (basic kit) + $20 (labor) = $34
- Cost per Stage 2 Kit: $34 / 2 = $17
- Selling Price per Stage 2 Kit: $35
- Profit per Stage 2 Kit: $35 (selling price) – $17 (cost) = $18
Incremental Analysis:
Comparing the two options, the profit per kit is:
- Basic Introductory Kit Profit: $14 per kit
- Stage 2 Kit Profit: $18 per kit
The Stage 2 kit yields an additional profit of $4 per kit compared to the basic introductory kit.
Recommendation:
Based on the incremental analysis, Lori should carry the Stage 2 kit. Despite the additional labor cost, the efficiency gained by producing two Stage 2 kits from one basic kit, combined with the higher selling price, results in a higher profit margin per kit. This approach leverages Lori’s expertise in cutting and dyeing reeds more efficiently than her customers, allowing her to add value to the product and increase profitability.
It’s important to note that this analysis focuses on the quantitative financial aspects. Lori should also consider qualitative factors such as customer preferences, market demand for each type of kit, and her capacity to invest the additional time required for producing Stage 2 kits. However, from a purely financial perspective, the Stage 2 kit offers a superior profit margin, making it the preferable option.