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 20 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost.

Manufacturing overhead for year 1 totaled $800,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following:

	Chairs			Desks
Sales revenue	$	1,150,000		$	2,105,000
Direct materials		584,000			800,000
Direct labor		160,000			340,000

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 $650,000. 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? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)

Answer 1

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a - 1		Profit Margin
	Chairs	15%
	Desks	25%
a - 2	Chairs
	As Chairs gives less profit margin
b.	Estimated margin for desks - Year 2	18%
	Workings:
a - 1		Chairs	Desks
(i)	Sales Revenue	$       11,50,000	$       21,05,000
	Direct material	$          5,84,000	$          8,00,000
	Direct labor	$          1,60,000	$          3,40,000
	Overhead	$          2,56,000	$          5,44,000
(ii)	Total cost	$       10,00,000	$       16,84,000
(iii) = (i) - (ii)	Gross Profit	$          1,50,000	$          4,21,000
(iii) / (ii)	Profit Margin	15%	25%
		Chairs	Desks	Total
(i)	Direct labor	$          1,60,000	$          3,40,000	$ 5,00,000
(ii) = (i) / $500000	Weight	32%	68%
(ii) X $800000	Overhead	$          2,56,000	$          5,44,000	$ 8,00,000
b.		Desks
(i)	Sales Revenue	$       21,05,000
	Direct material	$          8,00,000
	Direct labor	$          3,40,000
	Overhead	$          6,50,000
(ii)	Total cost	$       17,90,000
(iii) = (i) - (ii)	Gross Profit	$          3,15,000
(iii) / (ii)	Profit Margin	18%