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 constraint) 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	$	1,450		$	1,985		$	1,450
Variable cost per unit	$	850		$	1,400		$	1,000
Upholstery labor-hours per unit	10 hours			13 hours			5 hours

Required:

1. Portsmouth is considering paying its upholstery laborers hourly compensation, in addition to their usual salaries, 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 $43 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 if it hires the nearby upholstering company to make Love Seats?

3. Should Portsmouth hire the nearby upholstering company?

Answer 1

Requirement (1)- Maximum overtime premium per hour

SOFA - Selling price per unit = $1,985 per unit

Less: SOFA - Variable cost per unit = $1,400 per unit

SOFA - Contribution margin per unit = $585 per unit

Upholstery shop time required to produce one unit = 13 Hours

Contribution margin per unit of the constrained resource = $45 per hour [$585 / 13 Hours]

Therefore, Maximum overtime premium per hour = $45 per hour

Requirement (2)- Additional contribution margin per hour

Particulars	Recliner	Sofa	Love Seat
Selling price per unit ($)	1,450	1,985	1,450
Less: Variable cost per unit ($)	850	1,400	1,000
Contribution per unit ($)	600	585	450
(/) Upholstery shop time required to produce one unit	10 Hours	13 Hours	5 Hours
Contribution per hour	$60 per hour	$45 per hour	$90 per hour

Additional contribution margin that the Portsmouth can earn = $47 per hour [$90 per hour - $43 per hour]

Therefore, the additional contribution margin per hour = $47 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 $47 per hour”.