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?

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

a.

The company should produce A20 , so that the company can earn the highest

income from the operations. This is because , since the number of machine hours

is the constraint, the company should manufacture the part which gives maximum

contribution per machine hour. As the total fixed costs are the same for ay product

this wil result in the highest income for the company.

Working:

	A10	A20	A30	A40
Total contribution margin	265000	450000	263000	525000
Production units	1000	250	750	600
Contribution margin per unit	265	1800	350.7	875
Machine hours per unit	2	4	1.5	3
Contribution margin per machine hour	132.50	450.00	233.78	291.67

b.

Total order for A10	1000	units
Loss of unit sales if the offer is accepted (1,000 -200)	800	units
Loss of contribution on this ($265 * 800)	212000
Extra price offered by Polaris Airline (10% of $1,500)	150
Number of units ordered	200
Additional revenue from the order (150 x 200)	30000
Net gain (loss) if the order is acceted (30,000 - 212,000)	-182000
Since the Polaris order results in a loss the company should not
accept the offer.

c.

The annual capacity will increase by 25%. This means the available macnhine hours will increase by 1,500 hours (25% of 6,000).

Since A20 has the highest contribution margin per machine hour, the additional capacity shall be used to manufacture A20.

Since the additional contribution margin generated $675,000, is

higher than the annual cost $625,000 of the new technology, the

company should purchase the new technology.

Working:

Number of machine hours	1500
Contribution margin per machine hour	450
Total additional contribution margin	675000
Cost of the new technology	2500000
Estimated life - years	4
Annual cost	625000