Question

TufStuff, Inc., sells a wide range of drums, bins, boxes, and other containers that are used in the chemical industry. One of the company's products is a heavy-duty corrosion-resistant metal drum, called the WVD drum, used to store toxic wastes. Production is constrained by the capacity of an automated welding machine that is used to make precision welds. A total of 2,400 hours of welding time is available annually on the machine. Because each drum requires 0.8 hours of welding machine time, annual production is limited to 3,000 drums. At present, the welding machine is used exclusively to make the WVD drums. The accounting department has provided the following financial data concerning the WVD drums: $ 170.00 WVD Drums Selling price per drum Cost per drum: Direct materials Direct labor ($18 per hour) Manufacturing overhead Selling and administrative expense $46.60 4.50 5.25 17.50 73.85 Margin per drum $ 96.15 Management believes 3,500 WVD drums could be sold each year if the company had sufficient manufacturing capacity. As an alternative to adding another welding machine, management has considered buying additional drums from an outside supplier. Harcor Industries, Inc., a supplier of quality products, would be able to provide up to 1,500 WVD-type drums per year at a price of $130 per drum, which TufStuff would resell to its customers at its normal selling price after appropriate relabeling. Megan Flores, TufStuff's production manager, has suggested that the company could make better use of the welding machine by manufacturing bike frames, which would require only 0.2 hours of welding machine time per frame and yet sell for far more than the drums. Megan believes that TufStuff could sell up to 3,900 bike frames per year to bike manufacturers at a price of $75 each. The accounting department has provided the following data concerning the proposed new product: $ 75.00 Bike Frames Selling price per frame Cost per frame: Direct materials Direct labor ($18 per hour) Manufacturing overhead Selling and administrative expense $19.60 22.50 17.85 8.60 68.55 Margin per frame $ 6.45

Answer 1

Solution 1:

No, the Product margin as computed by accounting Department should not be used to make decision because it has considered allocated fixed costs also and fixed costs are irrelevant for such decisions. Variable costs should be considered while decision making.

Solution 2 and 3:

14 15 16 17 18 19 20 21 24 Solution 2: Computation of Contribution margin per unit (Assuming Direct Labor is Fixed cost) Manufactured Purchased WVD drums | WVD drums Bike frames Selling price $170.00 $170.00 $75.00 Variable costs: Direct materials $130.00 $46.60 $19.60 Variable manufacturing overhead $0.00 $1.26 $2.70 Variable selling and administrative $1.06 $1.06 $2.50 Total variable cost 131.06 48.92 $24.80 Contribution margin per unit $38.94 $121.08 $50.200 25 26 27 29 30 31 32 33 34 35 Solution 3a: Computation of Contribution margin per welding hour Manufactured WVD drums Bike frames Contribution margin per unit $121.08 $50.20 Welding hours per unit 0.8 0.2 Contribution margin per welding hour $151.35 $251.00 Ranking 36 37 38 39 40 41 42 Solution 3b: Compuation of WVD drums and/or bike frames to be manufactured/ purchased Hours Required Hours Left First Manufacture Bike Frames (3900*0.2 hour) 780 1620 Hours to Manufacture WVD Drums 1620 43 44 45 46 Units 48 49 50 Manufacture Bike frames Manufacture WVD Drums (1260/ 0.4) Purchase WVD Drums (3500-2025) 3900 2025 14751 52 53 54 55 56 57 58 Solution 3c: Computation of Net Operating Income resulting from this plan over current operations Units CM per unit | Total CM Bike Frames 3900 $50.20 $195,780 WVD Drums (Manufactured) 2025 $121.08 $245,187 WVD Drums (Purchased) 1475 $38.94 $57,437 Total Contribution margin from New Plan $498,404 Less: Contribution margin from Current operations (3000*$121.08) $363,240 Increase in Net Operating Income $135,164 59 60 -578 (7) Sheet265 (3) Sheet265 (4) Sheet280 Sheet281

Solution 4:

60 61 62 63 64 65 66 67 Solution 4a: Computation of Contribution margin per unit (Assuming Direct Labor is Variable cost) Manufactured Purchased WVD drums WVD drums Bike frames Selling price $170.00 $170.00 $75.00 Variable costs: Direct materials $130.00 $46.60 $19.60 Direct labor $0.00 $22.50 Variable manufacturing overhead $0.00 $2.70 Variable selling and administrative $1.06 $1.06 $2.50 Total variable cost $131.06 $53.42 $47.30 Contribution margin per unit $38.94 $116.58 $27.70 68 $4.50 69 $1.26 70 71 72 73 74 75 77 Solution 4b: Computation of Contribution margin per welding hour Manufactured WVD drums Bike frames Contribution margin per unit $116.58 $27.70 Welding hours per unit 0.8 Contribution margin per welding hour $145.73 $138.50 Ranking 79 0.2 80 82 83 84 85 Solution 4c: Compuation of WVD drums and/or bike frames to be manufactured/ purchased Hours Required Hours Left First Manufacture WDV Drums (3000*0.8 hour) 2400 Hours to Manufacture Bike frames ol 86 87 88 89 Units Manufacture WVD Drums Purchase WVD Drums (3500 - 3000) 3000 500 92 93 94 95 96 97 98 Solution 4d: Computation of Net Operating Income resulting from this plan over current operations Units CM per unit Total CM WVD Drums (Manufactured) 3000 $116.58 $349,740 WVD Drums (Purchased) 500 $38.94 $19,470 Total Contribution margin from New Plan $369,210 Less: Contribution margin from Current operations (3000* $116.58) $349,740 Increase in Net Operating Income $19,470 99 100 101 102 103 104 105 106 107 108 109 110 111 112 -578 (7) Sheet265 (3) Sheet265 (4) ) Sheet280 Sheet281