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 constriant) 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 $ 1,400 $ 1,800 $ 1,500 Variable cost per unit $ 800 $ 1,200 $ 1,000 Upholstery labor-hours per unit 8 hours 10 hours 5 hours Required: 1. Portsmouth is considering paying its upholstery laborers additional compensation 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 $45 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 provides the raw materials to the nearby company and then hires it to upholster the Love Seats? 3. Should Portsmouth hire the nearby upholstering company?

Answer 1

Answer:

1. 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?

“ Maximum amount payable per hour = $60 per hour “

SOFA - Selling price per unit                     = $1800

SOFA - Variable cost per unit                    = $1200

SOFA - Contribution margin per unit                 = $600

Upholstery shop time required to produce one unit = 10 Hours

Contribution margin per unit of the constrained resource = $600 / 10 Hrs = $60 per hour

2. How much additional contribution margin per hour can Portsmouth earn if it provides the raw materials to the nearby company and then hires it to upholster the Love Seats?

	Recliner	Sofa	Love Seat
Selling price per unit	$1400	$1800	$1500
Variable cost per unit	$800	$1200	$1000
Contribution per unit	$600	$400	$500
Upholstery shop time required to produce one unit	8	10	5
Contribution per hour	$75	$40	$100

Additional contribution margin that the Portsmouth can earn = $55 per hour

($100 per hour - $45 per hour )

3. Should Portsmouth hire the nearby upholstering company?

YES