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 constraint) in the production process is upholstery labor-hours. Information concerning three of Portsmouth's products appears below: Recliner Sofa Love Seat Selling price per unit $ 1,270 $ 1,750 $ 1,190 Variable cost per unit $ 850 $ 1,200 $ 850 Upholstery labor-hours per unit 7 hours 10 hours 4 hoursRequired:
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 $44 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

Answer:

1. $55 per hour

2. $41 per hour

3.Yes

Explanation:

1. Calculation to determine how much of an overtime premium per hour should the company be willing to pay.

Selling price per unit $ 1,750

Less Variable cost per unit ($1,200)

Contribution margin per unit (a) $ 550

Upholstery shop time required to produce one unit (b) 10 hours

Contribution margin per unit of the constrained resource (a) ÷ (b) $55 per hour

($550/10 hours)

Therefore the Maximum overtime premium per hour will be $55 per hour

2. Calculation to determine How much additional contribution margin per hour can Portsmouth earn

First step is to calculate the Contribution margin per unit of the constrained resource

Selling price per unit $ 1,190

Less Variable cost per unit ($850)

Contribution margin per unit (a) $ 340

Upholstery shop time required to produce one unit (b) 4hours

Contribution margin per unit of the constrained resource (a) ÷ (b) $85 per hour

($340/4 hours )

Now let calculate The additional contribution margin per hour earned by hiring the nearby company

Additional contribution margin per hour earned= $85 – $44

Additional contribution margin per hour earned= $41 per hour

Therefore The additional contribution margin per hour earned by hiring the nearby company will be $41 per hour

3. Yes . Portsmouth should hire the nearby upholstering company reason been that Portsmouth will earn an additional contribution margin of $41 per hour by hiring the nearby company