Question

McNulty, Inc., produces desks and chairs. A new CFO has just been hired and announces a new policy that if a product cannot earn a margin of at least 35 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost. Manufacturing overhead for year 1 totaled $945,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following. Chairs Desks Sales revenue $ 1,302,600 $ 3,017,000 Direct materials 602,000 980,000 Direct labor 160,000 470,000

Required: a-1. Based on the CFO's new policy, calculate the profit margin for both chairs and desks.

a-2. Which of the two products should be dropped? b. Regardless of your answer in requirement (a), the CFO decides at the beginning of year 2 to drop the chair product. The company cost analyst estimates that overhead without the chair line will be $830,000. The revenue and costs for desks are expected to be the same as last year. What is the estimated margin for desks in year 2?

Answer 1

	Chair	Desks
Sales Revenue	1,302,600	3,017,000
Direct Material	602,000	980,000
Direct Labor	160,000	470,000
Manufacturing Overhead	240,000	705,000
Product Cost	1,002,000	2,155,000
Gross margin	300,600	862,000
Margin %	30%	40%
Chairs should be dropped as margin is less than 35%
b.	Desks
Sales Revenue	3,017,000
Direct Material	980,000
Direct Labor	470,000
Manufacturing Overhead	830,000
Product Cost	2,280,000
Gross margin	737,000
Margin %	32.32%
Margin is 32.32%