Utilization of a Constrained Resource [LO 7–5, LO 7–6]
Barlow Company manufactures three products: A, B, and C. The selling price, variable costs, and contribution margin for one unit of each product follow:
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| Product | |||
| A | B | C | |
| Selling price. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $180 | $270 | $240 |
| Variable expenses: | |||
| Direct materials. . . . . . . . . . . . . . . . . . . . . . . . . . . . . | 24 | 72 | 32 |
| Other variable expenses. . . . . . . . . . . . . . . . . . . . . . | 102 | 90 | 148 |
| Total variable expenses. . . . . . . . . . . . . . . . . . . . . . . . | 126 | 162 | 180 |
| Contribution margin. . . . . . . . . . . . . . . . . . . . . . . . . . . . | $ 54 | $108 | $ 60 |
| Contribution margin ratio. . . . . . . . . . . . . . . . . . . . . . . . | 30% | 40% | 25% |
The same raw material is used in all three products. Barlow Company has only 5,000 pounds of raw material on hand and will not be able to obtain any more of it for several weeks due to a strike in its supplier’s plant. Management is trying to decide which product(s) to concentrate on next week in filling its backlog of orders. The material costs $8 per pound.
Required:
1. Compute the amount of contribution margin that will be obtained per pound of material used in each product.
2. Which orders would you recommend that the company work on next week—the orders for product A, product B, or product C? Show computations.
3. A foreign supplier could furnish Barlow with additional stocks of the raw material at a substantial premium over the usual price. If there is unfilled demand for all three products, what is the highest price that Barlow Company should be willing to pay for an additional pound of materials? Explain.
EXERCISE 7–10 Make or Buy a Component [LO 7–3]
For many years Futura Company has purchased the starters that it installs in its standard line of farm tractors. Due to a reduction in output, the company has idle capacity that could be used to produce the starters. The chief engineer has recommended against this move, however, pointing out that the cost to produce the starters would be greater than the current $8.40 per unit purchase price:
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| Per Unit | Total | |
| Direct materials. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | $3.10 | |
| Direct labor. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | 2.70 | |
| Supervision. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | 1.50 | $60,000 |
| Depreciation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | 1.00 | $40,000 |
| Variable manufacturing overhead. . . . . . . . . . . . . . . | 0.60 | |
| Rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . | 0.30 | $12,000 |
| Total production cost. . . . . . . . . . . . . . . . . . . . . . . . . | $9.20 |
A supervisor would have to be hired to oversee production of the starters. However, the company has sufficient idle tools and machinery that no new equipment would have to be purchased. The rent charge above is based on space utilized in the plant. The total rent on the plant is $80,000 per period. Depreciation is due to obsolescence rather than wear and tear.
Required:
Prepare computations showing how much profits will increase or decrease as a result of making the starters.