Question - Situation: Austin Wool Products purchases raw wool and processes it into spindles of yarn. Each month 4,000 spindles of yarn are produced. The spindles of yarn can then be sold directly to stores or they can be used by Austin Wool Products to make afghans. Each spindle of yarn sells for $12; variable costs are $8 to make a spindle of yarn, and fixed costs to make 4,000 spindles of yarn total $8,000.
The yarn can also be used to make afghans. Each afghan sells for $32 and requires one and a quarter (1.25) spindles of yarn. Excluding the cost of yarn, variable costs to make an afghan from spindles of yarn is $9, and fixed costs to make afghans from spindles of yarn is $20,000. If the company chooses to make afghans, all yarn must be used; no yarn can be sold separately.
Required:
a. In order to maximize profits, should Austin sell the spindles of yarn or further process the yarn into afghans? How much operating income would Austin generate on a monthly basis by following your suggestion?
b. What is the lowest selling price Austin should be willing to accept for one afghan as long as they can sell spindles of yarn to the outside market for $12 each?