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 constriant) 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	$	1,178		$	1,700		$	1,370
Variable cost per unit	$	800		$	1,150		$	1,050
Upholstery labor-hours per unit	7 hours			11 hours			4 hours

Required:

1. Portsmouth is considering paying its upholstery laborers additional compensation 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 $47 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 it provides the raw materials to the nearby company and then hires it to upholster the Love Seats?

Answer 1

Requirement (1)- Maximum overtime premium per hour

SOFA - Selling price per unit = $1,700 per unit

Less: SOFA - Variable cost per unit = $1,150 per unit

SOFA - Contribution margin per unit = $550 per unit

Upholstery shop time required to produce one unit = 11 Hours

Contribution margin per unit of the constrained resource = $50 per hour [$550 / 11 Hours]

“Therefore, Maximum overtime premium per hour = $50 per hour”

Requirement (2)- Additional contribution margin per hour

Particulars	Recliner	Sofa	Love Seat
Selling price per unit	$1,178	$1,700	$1,370
Less: Variable cost per unit	$800	$1,150	$1,050
Contribution per unit	$378	$550	$320
(/) Upholstery shop time required to produce one unit	7 Hours	11 Hours	4 Hours
Contribution per hour	$54 per hour	$50 per hour	$80 per hour

Additional contribution margin that the Portsmouth can earn = $33 per hour [$80 per hour - $47 per hour]

“Additional contribution margin per hour = $33 per hour”

Requirement (3) - Should Portsmouth hire the nearby upholstering company

“YES”. Portsmouth should hire the upholstering company, since it gives the additional contribution margin of $33 per hour”