Question

Barlow Company manufactures three products—A, B, and C. The selling price, variable costs, and contribution margin for one unit of each product follow:

	Product
	A				B				C
Selling price	$	180			$	270			$	240
Variable expenses:
Direct materials		24				80				32
Other variable expenses		102				90				148
Total variable expenses		126				170				180
Contribution margin	$	54			$	100			$	60
Contribution margin ratio		30	%			37	%			25	%

The same raw material is used in all three products. Barlow Company has only 6,000 pounds of raw material on hand and will not be able to obtain any more of it for several weeks due to a strike in its supplier’s plant. Management is trying to decide which product(s) to concentrate on next week in filling its backlog of orders. The material costs $8 per pound.

Required:

1. Calculate the contribution margin per pound of the constraining resource for each product.

2. Assuming that Barlow has unlimited demand for each of its three products, what is the maximum contribution margin the company can earn when using the 6,000 pounds of raw material on hand?

3. Assuming that Barlow’s estimated customer demand is 500 units per product line, what is the maximum contribution margin the company can earn when using the 6,000 pounds of raw material on hand?

4. A foreign supplier could furnish Barlow with additional stocks of the raw material at a substantial premium over the usual price. Assuming Barlow’s estimated customer demand is 500 units per product line and that the company has used its 6,000 pounds of raw material in an optimal fashion, what is the highest price Barlow Company should be willing to pay for an additional pound of materials?

Answer 1

1). Calculation of the contribution margin per pound:-

Hence using the Contribution margin per pound product A must be produced first and then Product C and in last product B.

2). Maximum contribution margin the company can earn when using the 6,000 pounds of raw material on hand.
= 6000 pounds * Contribution margin per pound of A
= 6000 pounds * $18
= $108,000 i.e Maximum contribution.

3). Assuming that Barlow’s estimated customer demand is 500 units per product line.

Maximum contribution margin = $27000 + $25000 + $30000 = $82,000

4). As we can see that out of 6000 pounds of material, total demand of A and C is met while the requirement is still in B because required material is 5000 pounds but allocated is 2500 hence if material is taken from foreign supplies it is required for B. So the price can be increased by contribution margin per pound which can be earned from B i.e. $10 hence the highest price which can be paid for additional material is
= Regular cost + Contribution margin per pound of B
= $ 8 + $10
= $18 per pound.