Incremental Analysis
Information Regarding Current Operations of the Farrell Corporation

Essay

Incremental analysis
Information regarding current operations of the Farrell Corporation is given below:
$$\begin{array} { | l | l | } \hline \text { Sales } & \$ 950,000 \\\hline \text { Variable Costs } & \$ 450,000 \\\hline \text { Fixed Costs } & \$ 310,000 \\\hline\end{array}$$ A proposed addition to Farrell's factory is estimated by the sales manager to increase sales by a maximum of $750,000. The company's accountants have determined that the proposed addition will add $320,000 to fixed costs each year.
(a) Explain why the existing $310,000 of fixed costs is a sunk cost while the $320,000 of fixed costs associated with the proposed addition is an out-of-pocket cost.
(b) Calculate by how much the proposed addition will either increase or reduce operating income.