Question

Portsmouth Company makes upholstered furniture. Its only variable cost is direct materials. The demand for the company's products far exceeds its manufacturing capacity. The bottleneck (or constriant) in the production process is upholstery labor-hours. Information concerning three of Portsmouth's upholstered chairs appears below:

	Recliner			Sofa			Love Seat
Selling price per unit	$	1,124		$	1,930		$	1,280
Variable cost per unit	$	800		$	1,150		$	800
Upholstery labor-hours per unit	6 hours			13 hours			6 hours

Required:

1. Portsmouth is considering paying its upholstery laborers additional compensation to work overtime. Assuming that this extra time would be used to produce sofas, up to how much of an overtime premium per hour should the company be willing to pay to keep the upholstery shop open after normal working hours?

2. A small nearby upholstering company has offered to upholster furniture for Portsmouth at a price of $55 per hour. The management of Portsmouth is confident that this upholstering company’s work is high quality and their craftsmen can work as quickly as Portsmouth’s own craftsmen on the simpler upholstering jobs such as the Love Seat. How much additional contribution margin per hour can Portsmouth earn if it provides the raw materials to the nearby company and then hires it to upholster the Love Seats?

3. Should Portsmouth hire the nearby upholstering company?

Answer 1

1. Maximum amount payable per hour = $60

2. Additional contribution margin per hour = $25

3. Yes

Explanation :

1.

	Sofa
Selling price per unit	$1,930
Variable cost per unit	$1,150
Contribution margin per unit	$780
Upholstery time required to produce one unit	13 hours
Contribution Margin per unit of constraint resource ($780 / 13)	$60 per hour

2.

	Recliner	Sofa	Love Seat
Selling price per unit	$1,124	$1,930	$1,280
Variable Cost per unit	$800	$1,150	$800
Contribution margin per unit	$324	$780	$480
Upholstery labor-hours per unit	6 hours	13hours	6 hours
Contribution Margin per unit of constraint resource	$54	$60	$80

Addition contribution margin = $80 - $55 = $25

3. Company should accept the offer for $55. If it increases the total production and sales for those chairs, company will earn net gain of $25.

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