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 constriant) in the production process is upholstery labor-hours. Information concerning three of Portsmouth's upholstered chairs appears below:

Recliner Sofa LoveSeat

Selling price per unit - $ 1,146 $ 1,700 $ 1,480

Variable cost per unit $ 750 $ 1,200 $ 1,000

Upholstery labor-hours per unit 6 hours 10 hours 6 hours

1. Portsmouth is considering paying its upholstery laborers additional compensation 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 $44 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

1.Maximum Overtime Premium per hour the Company should be willing to pay will be equal to the contribution earned per hour

Statement of Contribution per hour for Sofa

Sale Price	1,700
Variable Cost	1,200
Contribution Margin per Unit	$500
Labour Hours per Unit	10
Contribution Margin per Hour	$50

Hence, overtime premium per hour should the company be willing to pay to keep the upholstery shop open after normal working hours = $50

2. Additional contribution margin per hour can Portsmouth earn if if it hires the nearby upholstering company to make Love Seats:

Sale Price	1,480
Variable Cost	1,000
Contribution Margin per Unit	$480
Labour Hours per Unit	6
Contribution Margin per Hour	$80
Price paid per hour	$44
Additional Margin earned	$36

Hence, additional margin earned = $36

3. Since Portsmouth is getting additional contribution margin, it should hire the nearby upholstering company.