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: Selling price per unit Variable cost per unit Upholstery labor-hours per unit $ $ Recliner 1,340 $ 700 $ 10 hours Sofa Love Seat 1,790 $ 1,575 1,350 $ 1,200 11 hours 5 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 $37 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) The overtime premium per hour would be equal to contribution margin per labor hour from each set of sofa produced.

Calculation of Contribution margin per labor hour for sofa (Amounts in $)

Selling price per unit	1,790
Variable cost per unit	(1,350)
Contribution margin per unit	440
Labor hours required per unit	11 hrs
Contribution margin per labor hour ($440/11 hrs)	40 per hr

Therefore the company should be willing to pay $40 per hour to keep the upholstery shop open after normal working hours.

2) Firstly we need to calculate the contribution margin per hour for Love Seat which is shown as follows:

Calculation of Contribution margin per labor hour for Love Seat (Amounts in $)

Selling price per unit	1,575
Variable cost per unit	(1,200)
Contribution margin per unit	375
Labor hours required per unit	5 hrs
Contribution margin per labor hour ($375/5 hrs)	75 per hr

Additional contribution margin per hour = Contribution margin per hour - Cost per hour for external hirer

= $75 per hour - $37 per hour = $38 per hour

Therefore Portsmouth can earn additional contribution margin of $38 per hour.

3) Portsmouth can earn additional contribution margin of $38 per hour by hiring the nearby upholstering company for love seats (as shown in part 2).

Therefore, the Portsmouth should hire the nearby upholstering company.