Question

McNulty, Inc., produces desks and chairs. A new CFO has just been hired and announces a new policy that if a product cannot earn a margin of at least 15 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost.

Manufacturing overhead for year 1 totaled $935,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following:

	Chairs			Desks
Sales revenue	$	1,214,400		$	2,210,400
Direct materials		591,000			870,000
Direct labor		190,000			360,000

                          

Required:

a-1. Based on the CFO's new policy, calculate the profit margin for both chairs and desks.

a-2. Which of the two products should be dropped?

	Chairs
	Desks

b. Regardless of your answer in requirement (a), the CFO decides at the beginning of year 2 to drop the chair product. The company cost analyst estimates that overhead without the chair line will be $720,000. The revenue and costs for desks are expected to be the same as last year. What is the estimated margin for desks in year 2? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 1 decimal place.)

Answer 1

Solution a1:

Overhead cost for year 1 = $935,000

Direct labor cost for year 1 = $190,000 + $360,000 = $550,000

Overhead allocation rate = $935,000 / $550,000 = 170% of direct labor cost

Computation of Profit Margin - Mc Nulty Inc.
Particulars	Chairs	Desks
Sales Revenue	$1,214,400.00	$2,210,400.00
Product Cost:
Direct materials	$591,000.00	$870,000.00
Direct labor	$190,000.00	$360,000.00
Overhead (170% of direct labor cost)	$323,000.00	$612,000.00
Total Product Cost	$1,104,000.00	$1,842,000.00
Product Gross Profit	$110,400.00	$368,400.00
Profit Margin (Product Gross Profit / Product Cost)	10%	20%

solution a2:

Profit margin for chair is less than 15%, therefore product Chairs should be dropped.

Solution b:

Estimated margin of desk for year 2 - Mc Nulty Inc.
Particulars	Desks
Sales Revenue	$2,210,400.00
Product Cost:
Direct materials	$870,000.00
Direct labor	$360,000.00
Overhead	$720,000.00
Total Product Cost	$1,950,000.00
Product Gross Profit	$260,400.00
Profit Margin (Product Gross Profit / Product Cost)	13.4%