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 upholstered chairs appears below:

	Recliner			Sofa			Love Seat
Selling price per unit	$	1,196		$	1,645		$	1,220
Variable cost per unit	$	700		$	1,150		$	900
Upholstery labor-hours per unit	8 hours			11 hours			4 hours

Required:

1. Portsmouth is considering paying its upholstery laborers hourly compensation, in addition to their usual salaries, 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 $39 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 hires the nearby upholstering company to make Love Seats?

3. Should Portsmouth hire the nearby upholstering company?

Answer 1

1
	Sofas
Selling price per unit	1645
Less: Variable cost per unit	1150
Contribution margin per unit	495
Upholstery shop time required to produce one unit	11
Contribution margin per unit of the constrained resource	45
Maximum overtime premium per hour = $45
2
	Love seat
Selling price per unit	1220
Less: Variable cost per unit	900
Contribution margin per unit	320
Upholstery shop time required to produce one unit	4
Contribution margin per unit of the constrained resource	80
Less: Additional cost per hour	39
Additional Contribution margin per hour	41
3
Yes, hire the nearby upholstering company