Question

Sharp Aerospace has a five-year contract to supply North Plane with four specific spare parts for its fleet of airplanes. The following table provides information on selling prices, costs, and the number of units of each part that the company needs to produce annually according to the contract with North Plane:

	A10	A20	A30	A40
Sales	$1,500,000	$875,000	$450,000	$2,400,000
Variable costs	$1,235,000	$425,000	$187,000	$1,875,000
Contribution margin	$265,000	$450,000	$263,000	$525,000
Production in units	1,000	250	750	600
Machine hours/unit	2	4	1.5	3

Fixed overhead costs amount to $820,000 and are allocated based on the number of units produced. The company has a maximum annual capacity of 6,000 machine hours.

Questions:

a) If Sharp Aerospace could manufacture only one of the four parts, which spare part should it produce, based on the contribution margin per limited resource? Explain why.

b) Polaris Airline wants to buy 200 units of part A10 at 110% of the price currently paid by North Plane. Assume that for any of the four parts, Sharp Aerospace has to supply North Plane with at least 90% of the units specified in the contract. Should Sharp Aerospace accept the order for 200 units of part A10? Show using incremental analysis.

c) A new technology is available that costs $2,500,000 and would increase Sharp Aerospace's annual capacity by 25%. Should the company purchase the new technology? Assume that the technology has an estimated life for four years and that Sharp Aerospace can sell, at the same prices paid by North Plane, all the units it can produce of any of the four parts. Show all your calculations.

Answer 1

STATEMENT SHOWING CALCULATION OF CONTRIBUTION PER MACHINE HOUR
	A10	A20	A30	A40
Sales	$1,500,000	$875,000	$450,000	$2,400,000
Variable costs	$1,235,000	$425,000	$187,000	$1,875,000
Contribution margin	$265,000	$450,000	$263,000	$525,000
Machine hours/unit	2	4	1.5	3
Contribution Margin per machine Hour (Cont/Mach hr PU)	$132,500	$225,000	$131,500	$262,500
Ranking	III	II	Iv	I

Comment: Since Contribution per machine hour is maximum in case of Product A40. Sharp Aerospace should produce maximum of it.

B.

Particulars	Amount (Rs)
Contribution P U A10	265
Incremental contribution	58300	(265*1.10*200)
Less:
Contribution not earned on 133 units of A40	58625	(67*525000/600)
Net Loss if offer availed	-325
Comment: Offer should not be accepted
Working Note:
Since minimum 90% of the contracted product has to be supplied. So,
Total Hours Available			6000
Product	90% of demand	Total hours
A10	900	1800
A20	225	900
A30	675	1012.5
A40	540	1620	5332.5
	Remaining hours		667.5
Hours required to produce 1 unit of A10			2
Hours required too produce 200 unit of A10			400
If A10 was not produced than A40 would have been produced beinfg the maximum contribution
No of units required to produce A40	3
Total number of units would have been produced	67
3 Cost of Incremental technology $2,500,000 Contribution PU of A40 875 No of units 500 Total contribution per year 437500 Contribution received In four years 1750000 Net loss $750,000 Since total cost of technology will not bt able to recover so the new technology should not be bought Working note Increase in capacity 1500 (6000*25%) Since maximum contribution is from A40 , so maximum units of A40 should be produced No of units of A40 can be produced 1500/3 500