Question

Orange Inc. manufactures two products called Unit 1 and Unit 2. Revenue and expense amounts per unit are as follows:

Description

All amounts are Per Unit	Unit 1	Unit 2
Sales price	$39.00	$93.00
Costs:
Direct material	21.00	15.00
Direct manufacturing labor	3.00	18.00
Overhead - variable	3.75	22.50
Overhead - fixed	2.00	12.00
Selling and administrative costs - Variable	2.25	1.50
Total expense	32.00	69.00
Operating income	$ 7.00	$ 24.00

Orange Inc's production process uses highly skilled labor, which is in short supply. The demand for these products in greater than the number that Orange Inc. can make (limited in how many they can make due to the difficulty in finding the necessary skilled labor). The same skilled employees produce both products and earn the same wage rate when producing either product.

REQUIRED:

Assuming that the skilled employees earn $12 per hour, which product is most profitable. Please show your work and provide a short explanation.

Answer 1

Special labours are the bottleneck resource.

Calculation of labour hours taken per each unit

Labour cost p.u = Labours hours required per unit x Hourly rate

Unit 1

$3 = Labours hours required per unit x $12

Labours hours required per unit = 0.25hrs

Unit 2

$18 = Labours hours required per unit x $12

Labours hours required per unit = 1.5hrs

Particulars	Unit 1	Unit 2
Sales Price	$             39.00	$         93.00
Less: Variable costs
Direct Material	$             21.00	$         15.00
Direct Labour	$               3.00	$         18.00
Overhead - Variable	$               3.75	$         22.50
Contribution margine per unit	$             11.25	$         37.50
Labour Hours taken to per unit	0.25	1.5
Contribution margin per hour	$           156.00	$         62.00

Unit one is the most profitabl product since it has the highest contribution margin per hour

Verification: Suppose say we have 500hrs of special labour

Particulars	Industrial	Residential
Hours Available	500	500
No. of units that can be made	2,000.00	333.33
Contribution margine per unit	$             11.25	$         37.50
Total Contribution	$     22,500.00	$ 12,500.00
Fixed overhead	$       4,000.00	$   4,000.00
Selling expense	$       4,500.00	$       500.00
Profit	$     14,000.00	$   8,000.00