Question

Exercise 12-8 Volume Trade-Off Decisions [LO12-5, LO12-6]

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	$	180			$	270			$	240
Variable expenses:
Direct materials		24				80				32
Other variable expenses		102				90				148
Total variable expenses		126				170				180
Contribution margin	$	54			$	100			$	60
Contribution margin ratio		30	%			37	%			25	%

The same raw material is used in all three products. Barlow Company has only 6,000 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 6,000 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 6,000 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 6,000 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

1.

		A	B	C
a	Direct Material Cost per unit	$                24.00	$               80.00	$               32.00
b	Material Cost per pound	$                  8.00	$                 8.00	$                  8.00
c	Pounds of Material Per unit (a/b)	3	10	4
d	Contribution Margin per unit	$                54.00	$            100.00	$               60.00
e	Contribution margin per pound of raw material (d/c)	$                18.00	$               10.00	$               15.00

2.
Since Contribution margin per pound of raw material is highest for Product A, first of all Product A will be produced and then Product C, then Product B

Product A maximum units production with given raw material = 6000 / 3 = 2000 units
Contribution Margin = 2000 x $54 = $108000

Maximum Contribution with unlimited demand = $108000

3.

Pounds of Material Required per unit	3	10	4
Pounds of Material Required for 500 units	1500	5000	2000

Since Product A requires 1500 pounds of material and Product B requires 2000 pounds of material, 500 units for both can be produced and remaining material i.e. 2500 pounds i.e. 6000 - 1500 - 2000, therefore 250 units can be produced for Product C i.e. 2500 / 10

Maximum Contribution
Product A = 500 x $54 = $27000
Product B = 250 x $100 = $25000
Product C = 500 x $60 = $30000
Total Contribution = $82000

4.
The maximum price that can be paid is equal to lowest contribution margin per pound + original cost i.e $10 + $8 = $18