Question

McNulty, Inc., produces desks and chairs. A new CFO has just been hired and announces a new policy that if a product cannot earn a margin of at least 25 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost.

Manufacturing overhead for year 1 totaled $630,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following.

	Chairs			Desks
Sales revenue	$	1,106,400		$	2,033,200
Direct materials		586,000			820,000
Direct labor		140,000			310,000

Required:

a. Based on the CFO's new policy, calculate the profit margin for both chairs and desks.

b. Regardless of your answer in requirement (a), the CFO decides at the beginning of year 2 to drop the chair product. The company cost analyst estimates that overhead without the chair line will be $670,000. The revenue and costs for desks are expected to be the same as last year. What is the estimated margin for desks in year 2?

A- Profit margin

Chairs- % ?

Desks- % ?

Req B- Estimated margin for desk- Year 2 : %?

Answer 1

Answer to part 1.

Gross profit calculation
	Chair	Desk
Sales		$        1,106,400		$          2,033,200
Direct Materials	$       (586,000)		$       (820,000)
Direct Labour	$       (140,000)		$       (310,000)
Manufacturing Overheads	$       (196,000)		$       (434,000)
Total Cost		$         (922,000)		$       (1,564,000)
Gross Profit		$            184,400		$             469,200
Gross Profit %		20%		30%

Manufacturing overhead allocated to chairs = = $196,000

Manufacturing overhead allocated to desks = = $434,000

Based on CFO policy, chair division of the company should be dropped since profit margin of that division is less than 25%.

Answer to part 2.

Gross profit calculation
	Desk
Sales		$          2,033,200
Direct Materials	$       (820,000)
Direct Labour	$       (310,000)
Manufacturing Overheads	$       (670,000)
Total Cost		$       (1,800,000)
Gross Profit		$             233,200
Gross Profit %		13%