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	$	1,400		$	1,800		$	1,500
Variable cost per unit	$	800		$	1,200		$	1,000
Upholstery labor-hours per unit	8 hours			10 hours			5 hours

Required:

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 $45 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

Calculation of Contribution Margin per labour hour
	Recliner	Sofa	Love Seat
Selling price per unit	$1,400.00	$1,800.00	$1,500.00
Less : Variable cost per unit	$800.00	$1,200.00	$1,000.00
Contribution Margin per unit	$600.00	$600.00	$500.00
/ Labour hours per unit	8	10	5
Contribution Margin per labour hour	$75.00	$60.00	$100.00
Answer 1
Contribution margin per labour hour for sofa is $60.
Hence, Portsmouth can pay upto $60 as an overtime premium per hour to keep the upholstery shop open after normal working hours.
Answer 2
Contribution margin per labour hour for Love seat is $100.
Price offered by nearby upholstering company to make Love seat = $45 per hour
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 = $100 - $45 = $55 per hour
Answer 3
Yes , Portsmouthshould hire the nearby upholstering company