Question

Explain incremental revenues and incremental costs. Provide a business example for each of these terms.

Answer 1

Incremental revenue refers to the additional revenue that a company would be able to generate if under a given scenario, it accepts it. This means, that the extra revenue the company will generate if it uses the given opportunity The opportunity could be in form of make or buy decision or accepting a special order or discontinuing a segment or selling at split off or processing further. Any revenue opportunity would usually also be accompanied by some cost. The cost to accept such opportunity is incremental cost. That is additional cost incurred to accept the opportunity or scenario is known as incremental cost. Example is as follows: The happy Hop prepares return gift kits for various types of c celebrations' is currently operating at 80% of its capacity. It costs $5 to make a kit that it sells for $25.00. It currently makes and sells 80,000 kits per year The Happy Hop has received a special-order request for 20,000 packets at a price of $20 per packet to be shipped overseas. This transaction would not have any affect on current sales. If 80,000 kits is 80% of capacity, 100,000 kits would be 100% of capacity. The Happy Hop has the capacity to prepare the 20,000 kits requested without changing its existing operations In this scenario, the revenue so generated if special order is accepted which is 20,000 units $20 is incremental revenue and the variable cost that will be incurred for each additional unit so produced, which would be $5*20000 units is incremental cost Note: For any queries, doubts please post in comment section.