Question

A fire recently destroyed a substantial portion of Swifty Company’s production capacity. It will be many months before capacity can be restored. During this period, demand for the firm’s products will exceed the company’s ability to produce them. Per-unit data on the firm’s three major products is summarized as follows:

Product		A		B		C
Selling price		$75		$95		$71
Variable costs		33		31		22
Fixed costs		15		19		9
Operating profit		$27		$45		$40

Fixed costs have been allocated to the products on the basis of the labour hours required to produce each product. The major capacity constraint is the availability of time on a processing machine. Each unit of Product A and Product C requires 2 hours of processing on the machine, whereas Product B requires 3 hours.

Assume that the firm has enough capacity to meet the demand of products B and C. If estimated demand for the next product to be produced, product A, exceeds capacity by 1,060 units, what is the maximum amount the firm would be willing to pay to increase capacity?

Answer 1

	Product A	Product B	Product C
Selling price	75	95	71
Variable costs	33	31	22
Contribution Margin	42	64	49
Machine Hour per unit	2	3	2
Contribution per MH	21.00	21.33	24.50
Ranking of Production	3rd	2nd	1st

Company will be able to meet demand for Product A & B with current capacity.

In case of Product A, there will be unsatisfied demand to the tune of 1060 units due to lack of capacity.

However, the company can have additional capacity.

Maximum Amount that the firm can pay to increase capacity = 1060 units* $42/unit = $44520