Question

Exercise 6-8 (Algo) Volume Trade-Off Decisions [LO6-5, LO6-6]

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	$	160			$	270			$	210
Variable expenses:
Direct materials		16				80				24
Other variable expenses		108				90				144
Total variable expenses		124				170				168
Contribution margin	$	36			$	100			$	42
Contribution margin ratio		23	%			37	%			20	%

The same raw material is used in all three products. Barlow Company has only 5,700 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 5,700 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 5,700 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 5,700 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

Compute contribution margin per pound

Particular	product A	Product B	Product C
Contribution margin per pound	$36	$100	$42
Direct material cost unit	$16	$80	$24
Direct material cost per pound	$8	$8	$8
Pounds of material required per unit	2($16/$8)	10($80/$8)	3($24/$8)
Contribution margin per pound	($36/2) $18	($100/10) $10	($42/3) $14

2) Product A contribution margin per pound is highest among the three

	Product A
Contribution margin per pound	$18
Pounds of material available	5700
Contribution margin	$102600

3)

	A	B	C	total
Contribution margin per pound	$18	$10	$14
Maximum demand for each product line	500	500	500
Pound of material required per unit	2	10	3
Product of material required to produce maximum demand units for each product line	(500×2) 1000	(500×10) 5000	(500×3) 1500
Pounds of material used to optimal manner	1000	3200	1500
Maximum contribution margin with 5700pounds of material	(1000×$18) $18000	(3200×$10) $32000	(1500×$14) $21000	$71000

Maximum contribution margin = $71000

4) with 5700 pounds of material demand of Product A and C Fully satisfied and Product B is partly fulfilled

Maximum pound of price for additional material and contribution margin per pound of product B is taken

therefore highest price willing to pay for pound is

Cost PER pound of material = $8

Contribution margin per pound of product B = $10

Maximum price per pound = $18

Highest price willing to pay for pound = $$18

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