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.

Required:

1. Determine the unit contribution margin for each product.

	Contribution Margin Per Unit
High Grade	$
Good Grade	$
Regular Grade	$

2. Provide an analysis to determine the relative product profitability, assuming that the furnace is a bottleneck. Round your answers to two decimal places.

	Contribution Margin Per furnace Hour
High Grade	$
Good Grade	$
Regular Grade	$

Answer 1

a
	High Grade	Good Grade	Regular Grade
Unit selling price	280	270	250
Less: Variable costs
Direct materials cost per unit	90	84	80
Variable conversion cost	180	165	150
Contribution Margin Per Unit	10	21	20
b
	High Grade	Good Grade	Regular Grade
Contribution Margin Per Unit	10	21	20
Divide by Furnace hours per unit	4	3	2.5
Contribution Margin Per furnace Hour	2.50	7.00	8.00
Workings:
	High Grade	Good Grade	Regular Grade
Variable conversion cost	=12*15	=11*15	=10*15