This question relates to the December 2013 - Q1 Process Co
Extract: Product L
- 1200kg can be sold for $5.60 per kg or processed further and sold for $6.70 per kg
- further processing cost is $0.50 per kg
- there is a loss of 5% during further processing.
- calculate whether the product should be further processed or not.
Calculation: Incremental Revenue
- Revenue after further processing 1200*0.95*6.70 = 7,638
- Revenue if not processed further 1200*5.60 = 6,720
- Net profit/ loss 918 (additional profit)(understood)
Less: Incremental Variable cost (1,200*0.95*0.5) = -560
Marginal Income 358 (additional profit therefore Product L should be further processed.
Question
I don't understand why we only take 95% of the product when calculating incremental variable cost. At the start of the process there is 1,200kg and 5% is lost during production.
The loss of 5% is taken into account when calculating the additional revenue.