Question

Tanek Industries manufactures and sells three different models of wet-dry shop vacuum cleaners. Although the shop vacs vary in terms of quality and features, all are good sellers. Tanek is currently operating at full capacity with limited machine time. Sales and production information relevant to each model follows. Selling price Variable costs and expenses Machine hours required Economy $36 $19 0.5 Product Standard $60 $24 0.8 Deluxe $120 $56 1.6 Calculate contribution margin per unit. Product Standard Economy Deluxe Contribution margin per unit $ $ $

Answer 1

Calculation of contribution margin per unit : Contribution margin is the excess of selling price per unit of a product over the variable cost of producing it. It is calculated as below   

Economy Standard Deluxe

Selling Price $ 36 60 120

Variable cost and expenses $ 19 24 56

Contribution margin per unit $ 17 36 64

Ignoring the machine time constraint, which single product shound Tanek Industries produce?  

Economy Standard Deluxe

%age of Contribution margin per unit to its selling price: 47.22% 60% 53.33%

It is clear from the above that the company is earning the highest Contribution margin per unit in case of the Standard product. Hence it will be more profitable for Tanek Industries to produce Standard Vacuum cleaners.

Calculation of Contribution Margin per unit of limited resource:

Many companies have a constraint of some limited resource such as machine hours available, labour hours available etc. In these circumstances, it is most beneficial for the company to produce that product which maximises its profits per unit. Contribution Margin per unit of limited resource is calculated by dividing the Contribution Margin per unit by the per unit limited resource required (which is machine hours in this case).

   Economy Standard Deluxe

Contribution margin per unit $ (A) 17    36 64

Machine Hours required per unit (B) 0.5 0.8 1.6

Contribution Margin per unit of limited resource (A divided by B) 34 45 40

It is clear from the above that the company is earning the highest Contribution margin per unit of limited resource of 45 in case of Standard product. Hence it will be more profitable for Tanek Industries to produce the Standard Vacuum cleaners on this parameter also.

If additional machine time could be obtained, How should it be used?:

If additional machine time could be obtained, the same should be used first of all to produce the Standard product as the margin generated by the Standard product is the highest among its products both in terms of percentage of Contribution margin per unit as well as Contribution margin per unit of limited resource. If there is still some machine time available left, it can be used to produce Deluxe product which is the second highest in terms of Contribution margin per unit and Contribution margin per unit of limited resource. The remaining available machine time, if any, can be used to produce the Economy product.