Question

TufStuff, Inc., sells a wide range of drums, bins, boxes, and other containers that are used in the chemical industry. One of the company's products is a heavy-duty corrosion-resistant metal drum, called the WVD drum, used to store toxic wastes. Production is constrained by the capacity of an automated welding machine that is used to make precision welds. A total of 2,000 hours of welding time is available annually on the machine. Because each drum requires 0.4 hours of welding time, annual production is limited to 5,000 drums. At present, the welding machine is used exclusively to make the WVD drums. The accounting department has provided the following financial data concerning the WVD drums:
Management believes 6,000 WVD drums could be sold each year if the company had sufficient manufacturing capacity. As an alternative to adding another welding machine, management has considered buying additional drums from an outside supplier. Harcor Industries, Inc., a supplier of quality products, would be able to provide up to 4,000 WVD-type drums per year at a price of $138 per drum, which TufStuff would resell to its customers at its normal selling price after appropriate relabeling.
Megan Flores, TufStuff's production manager, has suggested that the company could make better use of the welding machine by manufacturing bike frames, which would require only 0.5 hours of welding time per frame and yet sell for far more than the drums. Megan believes that TufStuff could sell up to 1,600 bike frames per year to bike manufacturers at a price of $239 each. The accounting department has provided the following data concerning the proposed new product:

The bike frames could be produced with existing equipment and personnel. Manufacturing overhead is allocated to products on the basis of direct labor-hours. Most of the manufacturing overhead consists of fixed common costs such as rent on the factory building, but some of it is variable. The variable manufacturing overhead has been estimated at $1.35 per WVD drum and $1.90 per bike frame. The variable manufacturing overhead cost would not be incurred on drums acquired from the outside supplier.
Selling and administrative expenses are allocated to products on the basis of revenues. Almost all of the selling and administrative expenses are fixed common costs, but it has been estimated that variable selling and administrative expenses amount to $0.75 per WVD drum whether made or purchased and would be $1.30 per bike frame.
All of the company's employees-direct and indirect-are paid for full 40 -hour workweeks and the company has a policy of laying off workers only in major recessions.

Required:
Given the margins of the two products as indicated in the reports submitted by the accounting department, does it make sense to consider producing the bike frames? Explain.

Answer 1

No, because it took into account allocated fixed expenses as well, the Product Margin as calculated by the Accounting Department should not be used to make such decisions. When making decisions, variable costs should be taken into account.

What is the profit margin?

Profitability is gauged by profit margin. Finding the profit as a proportion of revenue is used to calculate it. Gross profit margin, operating profit margin, and net profit margin are the three different forms of profit margins. Gross profit is multiplied by net sales to determine gross profit margin.

The product's gross profit margin is determined by the discrepancy between the selling price and the product cost. The gross profit margin is divided by the selling price to produce the product margin. Product margin is equal to the product's selling price divided by its cost. Typically, product margins are expressed as percentages.

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