Question

Product pricing and profit analysis with bottleneck operations

Hercules Steel Company produces three grades of steel: high, good, and regular grade. Each of these products (grades) has high demand in the market, and Hercules is able to sell as much as it can produce of all three. The furnace operation is a bottleneck in the process and is running at 100% of capacity. Hercules wants to improve steel operation profitability. The variable conversion cost is $15 per process hour. The fixed cost is $200,000. In addition, the cost analyst was able to determine the following information about the three products:

	High Grade			Good Grade			Regular Grade
Budgeted units produced		5,000			5,000			5,000
Total process hours per unit		12			11			10
Furnace hours per unit		4			3			2.5
Unit selling price		$280			$270			$250
Direct materials cost per unit		$90			$84			$80

The furnace operation is part of the total process for each of these three products. Thus, for example, 4.0 of the 12.0 hours required to process High Grade steel are associated with the furnace.

Instructions

Determine the unit contribution margin for each product.

Provide an analysis to determine the relative product profitability, assuming that the furnace is a bottleneck.

Answer 1

1.contribution margin per unit of product:

	unit contribution margin
high grade	$10
good grade	$21
regular grade	$20

working:

	high grade	good grade	regular grade
unit selling price	$280	$270	$250
less:variable conversion cost($15 *12, 11, 10)	(180)	(165)	(150)
less:direct material cost per unit	(90)	(84)	(80)
contribution per unit	$10	$21	$20

2.

	contribution margin per furnace hour
high grade	$2.50
good grade	$7.00
regular grade	$8.00

working:

	high grade	good grade	regular grade
contribution per unit /furnance hours unit	($10/4)=>$2.50	($21/3)=>$7	($20/2.5)=>$8