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	$	1,078		$	2,060		$	1,525
Variable cost per unit	$	700		$	1,400		$	1,100
Upholstery labor-hours per unit	7 hours			12 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 $49 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

Requirement 1

First lets find contribution margin per unit of Sofa.

Selling price per unit of Sofa = $2,060

Variable cost per unit of Sofa = $1,400

Contribution margin per unit of Sofa =  Selling price per unit of Sofa - Variable cost per unit of Sofa = $2,060 - $1,400 = $660

Now lets find the contribution margin per Upholstery labor-hours per unit = $660 / 12 hours per unit = $55.

So from the above we can understand that, the business makes $55 per hour for each Sofa made.

The company be willing to pay anything less than $55 to keep the upholstery shop open after normal working hours, because it makes more money on each hour extra open in that case.

Requirement 2

First lets find contribution margin per unit of Love seat.

Selling price per unit of Love seat = $1,525

Variable cost per unit of Love seat = $1,100

Contribution margin per unit of Love seat =  Selling price per unit of Love seat - Variable cost per unit of Love seat = $1,525 - $1,100 = $425

Now lets find the contribution margin per Upholstery labor-hours per unit = $425 / 5 hours per unit = $85.

So from the above we can understand that, the business makes $85 per hour for each love seat made.

Offer price by nearby upholstering company = $49

additional contribution margin per hour can Portsmouth earn if if it hires the nearby upholstering company to make Love Seats = $85 - $49 = $36

Requirement 3

Portsmouth should hire the nearby upholstering companyfor the incremental benefit of $36 per hour.