Question

please show me step by step? Chapter 11

Exercise 11-8 Volume Trade-Off Decisions [LO11-5, LO11-6]

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

Solution

Barlow Company

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

		Products
	A	B	C
Selling price per unit	$180	$270	$240
Contribution margin per unit	$54	$100	$60
Direct material	$24	$80	$32
Direct material cost per pound	$8	$8	$8
Direct material - pounds per unit	24/8 = 3 pounds	80/8 = 10 pounds	32/8 = 4 pounds
contribution margin per pound	54/3 = $18	100/10 = $10	60/4 = $15

1. Assuming unlimited demand for three products, determination of maximum contribution margin using the 6,000 pounds raw material:

The available raw materials on hand should be used for the product that provides highest contribution margin per pound. From the above calculations, the Product A earns highest contribution margin per pound at $18, Product C earns the next highest at $15 and Product B earns the least contribution margin per pound at $10.

Hence, the company should use the entire 6,000 pounds of raw material to produce Product A to maximize contribution margin.

Estimated Maximum contribution margin using 6,000 pounds = available pounds x contribution margin per pound

Maximum Contribution Margin = 6,000 x $18 = $108,000

1. Determination of the maximum contribution margin to meet the assumed demand of 500 units per product line:

As per ranking ,

Product A earns highest contribution margin per pound. Hence, demand for Product A should be first met using the raw materials.

Demand = 500 units

Pounds per unit = 3

Pounds needed to meet demand for 500 units = 500 x 3 = 1,500 pounds

Remaining pounds of DM for Product C and Product B = 6,000 – 1,500 = 4,500

Product C earns the second highest contribution margin per pound.

Hence, demand for Product C should be met next using the remaining raw materials.

Demand = 500 units

Pounds per unit = 10

Pounds needed to meet demand for 500 units = 500 x 10 = 5,000

Since available raw materials is only 4,500 pounds, number of units of Product C that can be produced using 4,500 pounds = 4,500/10 = 450 units

No raw materials are left for production of Product B.

Maximum Contribution margin –

500 units of Product A = 500 x $54 = $27,000

450 units of Product C = 450 x 60 = $27,000

Total maximum Contribution to the company = 27,000 + 27,000 = $54,000

1. Determination of the highest price the company would pay for additional pound of raw materials:

The highest price would be = price per pound + contribution margin for the product that needs additional raw materials

The company needs to produce 50 units (500 – 450) more to meet the demand for Product C.

The highest price to meet the demand for C = $8 + $15 = $23

The highest price to meet the demand for B = $8 + $10 = $18