Question

Portsmouth Company makes fine colonial reproduction furniture. Upholstered furniture is one of its major product lines and the bottleneck on this production line is time in the upholstery shop. Upholstering is a craft that takes years of experience to master and the demand for upholstered furniture far exceeds the company's capacity in the upholstering shop. Information concerning three of the company's upholstered chairs appears below: Selling price per unit Variable cost per unit Upholstery shop time required to produce one unit Recliner $1,410 $750 10 hours Sofa S1,885 $1,300 13 hours Love Seat $1.500 $1.100 5 hours Required: 1. More time could be made available in the upholstery shop by asking the employees who work in this shop to work overtime. Assuming that this extra time would be used to produce sofas, up to how much should the company be willing to pay per hour to keep the upholstery shop open after normal working hours? Maximum amount payable per hour 2. A small nearby upholstering company has offered to upholster furniture for Portsmouth at a fixed charge of $43 per hour. The management of Portsmouth is confident that this upholstering company's work is high quality and their craftsmen should be able to work about as quickly as Portsmouth's own craftsmen on the simpler upholstering jobs such as the love seat. Should management accept this offer? O Yes O No

Answer 1

28 1) The company can determine how much they would be willing to pay by computing the contribution margin per unit of the constrained resource 29 30 Love Seat Sofa Recliner Selling Price Per Unit 32 1410 1885 1500 Less Variable Cost Per Unit -750 33 -1300 -1100 Contribution Margin Per Unit (A) 660 400 34 585 Number of Upholstery Hours Per Unit (B) 35 10 13 Contribution Margin Per Hour (A/B) 36 66 45 80 37 As the Contribution Margin Per Hour in case of Sofa is less than Recliner and Love Seat 38 therefore, the maximum amount the company will pay equals to the contribution margin 39 40 per hour of Sofa i.e. $45 41 42 Maximum amount payable Per Hour 45 43 44 2) Contribution Margin Per Hour 80 Less Fixed Charge Additional Contribution Margin Per Hour 45 -43 46 37 47 48 Yes, management should accept the offer. 49