Question

Two different products that have the following price and cost characteristics.

Selling price per unit: Bicycle: 100 Tricycle: 400

Variable cost per unit: Bicycle: 40 Tricycle: 240

Management believes that pushing sales of the Bicycle product would maximize company profits because of the high contribution margin per unit for this product. However, only 50,000 labor hours are available each year, and the Bicycle product requires 4 labor hours per unit while the Tricycle model requires 2 labor hours per unit. The company sells everything it produces.

Required:

a. Calculate the contribution margin per unit of constrained resource for each model.

b. Which model would CyclePath prefer to sell to maximize overall company profit? Explain.

Answer 1

• All working forms part of the answer
• Requirement ‘a’

Working		Bicycle	Tricycle
A	Selling price per unit	$                100.00	$                400.00
B	Variable cost per unit	$                   40.00	$                240.00
C = A - B	Contribution margin per unit	$                   60.00	$                160.00
D	No. of labor hours required per unit	4	2
E = C/D	Contribution per labor hours = Contribution margin per unit of constrained resource	$                   15.00 per labor= ANSWER	$                  80.00 per labor hour = ANSWER

• Requirement ‘b’

The company should sell TRICYCLE model.

When the resources are LIMITED, that product is produced or given preference over other product(s) that has MAXIMUM CONTRIBUTION MARGIN per unit of that ‘limited resource’.

In our question, labor hours are limited to be 50,000 only.

1 labor hour spent on Bicycle will earn $ 15, while 1 labor hour spent on Tricycle will earn $ 80.

Hence, Cyclepath should prefer to sell TRICYCLE to maximise overall Company Profits.