Question

Stefanovich 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			$	280			$	240
Variable expenses:
Direct materials		24				80				32
Other variable expenses		102				100				148
Total variable expenses		126				180				180
Contribution margin	$	54			$	100			$	60
Contribution margin ratio		30	%			35.71	%			25	%

The same raw material is used in all three products. The company has only 6,600 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.

A foreign supplier could furnish the company with additional stocks of the raw material at a substantial premium over the usual price. Assuming the company’s estimated customer demand is 500 units per product line and that the company has used its 6,600 pounds of raw material in an optimal fashion, what is the highest price the company should be willing to pay for an additional pound of materials?

Multiple Choice

• $18

• $23

• $18

• $10

Answer 1

Answer: $18

Working:

Contribution margin per pound:

	Product A	Product B	Product C
Contribution margin per unit             A	54	100	60
Direct material cost per unit	24	80	32
Direct material cost per pound	8	8	8
Pounds of material required per unit B	3	10	4
Contribution margin per pound    A/B	18	10	15
Ranking for optimal Mix	1	3	2

Statement showing allocation of 6,600 pounds of raw material to three products based on ranking

	Demand for Units	Pounds required
Product A	500	500*3 = 1500
Product C	500	500*4 = 2000
Product B Balance pounds (6,600-1,500-2,000)=3,100	3100/10 = 310	3100

Conclusion:

Demand for each product 500 units

· So out of 6,600 pounds of material, total demand of A and C is met while the requirement is still in B because required material is 5,000 pounds but allocated is 1,900 hence if material is taken from foreign supplies it is required for B.

· So the price can be increased by contribution margin per pound which can be earned from B i.e. $10

· hence the highest price which can be paid for additional material is

· Regular cost + Contribution margin per pound of B
= $ 8 + $10
= $18 per pound