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:

	Recliner			Sofa			Love Seat
Selling price per unit	$	1,156		$	1,805		$	1,200
Variable cost per unit	$	750		$	1,200		$	850
Upholstery labor-hours per unit	7 hours			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 $52 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 if it hires the nearby upholstering company to make Love Seats?

3. Should Portsmouth hire the nearby upholstering company?

Answer 1

1	Maximum overtime premium per hour	=	$          55
	Workings:
	Sofa:
	Selling price per unit	=	$    1,805
Less:	Variable cost per unit	=	$    1,200
(a)	Contribution per unit	=	$        605
(b)	Time required per sofa	=	11	hours
(a) / (b)	Maximum overtime premium per hour	=	$          55	per hour
2	Additional contribution margin per hour	=	$          18
	Workings:
	Love seat:
	Selling price per unit	=	$    1,200
Less:	Variable cost per unit	=	$        850
(a)	Contribution per unit	=	$        350
(b)	Time required per Love seat	=	5	hours
(a) / (b)	Contribution margin per hour	=	$          70	per hour
Less:	Fixed charge	=	$          52
	Additional Contribution margin per hour	=	$          18
3	Yes
	As above calculated under point 2 Additional Contribution margin per hour is positive, Therefore it is beneficial to accept the offer