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	Love SEat
Selling price per unit	1340	2060	1425
Variable cost per unit	800	1400	1000
Upholstry labor-hours per unit	9 hours	12 hours	5 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 $51 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 it provides the raw materials to the nearby company and then hires it to upholster the Love Seats?

3. Should Portsmouth hire the nearby upholstering company?

Answer 1

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?

“ Maximum amount payable per hour = $55 per hour “

SOFA - Selling price per unit                    = $2060     

SOFA - Variable cost per unit = $1400

SOFA - Contribution margin per unit = $660

Upholstery shop time required to produce one unit = 12 Hours

Contribution margin per unit of the constrained resource = $660 / 12 = $55 per hour

2. A small nearby upholstering company has offered to upholster furniture for Portsmouth at a price of $51 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 it provides the raw materials to the nearby company and then hires it to upholster the Love Seats?

	Recliner	Sofa	Love Seat
Selling price per unit	$1,340.00	$2,060.00	$1,425.00
Variable cost per unit	$800.00	$1,400.00	$1,000.00
Contribution per unit	$540.00	$660.00	$425.00
Upholstery shop time required to produce one unit	9	12	5
Contribution per hour	$60.00	$55.00	$85.00

Additional contribution margin that the Portsmouth can = $34 per hour

($85 per hour - $51 per hour )

3. Should Portsmouth hire the nearby upholstering company?

YES. Portsmouth should hire the nearby upholstering company