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	$	1,400		$	1,800		$	1,500
Variable cost per unit	$	800		$	1,200		$	1,000
Upholstery labor-hours per unit	8 hours			10 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 $45 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?

3. Should Portsmouth hire the nearby upholstering company?

Answer 1

Answer:

1)

Overtime premium per hour that company should pay - for Sofas          = (Selling price per Unit (-) Variable cost per Unit /    Labor Hours per Unit          =   ( $ 1,800 (-) $ 1,200 ) / 10 hours          =    $ 600 / 10 hours          =   $ 60

Maximum overtime premium per hour   =    $ 60 per hour

2)

Additional contribution margin per hour - for Love Seat       = (Selling price per Unit (-) Variable cost per Unit /Labor Hours per Unit ) (-) Addl. cost          =   ( $ 1,500 (-) $ 1,000 ) / 5 hours ) (-) $ 45 per hour          =    $ 100 per hour (-) $ 45 per hour          =     $ 55 per hour

Additional Contribution margin per hour =     $ 55 per hour

3)

Yes, portsmouth should hire the upholstering company, since there is Additional contribution margin of $ 55 per hour