Question

Exercise 10-6 Managing a Constrained Resource [LO10-6]

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	$ 1,280	$ 2,180	$ 1,360
Variable cost per unit	$ 700	$ 1,400	$ 1,000
Upholstery labor-hours per unit	10 hours	13 hours	4 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? HOME ACCESSIBILITY PREVIEW Maximum amount payable per hour + 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? Yes or no?

Answer 1

1). First we need to determine Contribution per unit of constraint which is hours so we need to determine the contribution per hour of labour.
Sofa:
Selling Price              $2180
Variable Cost             $1400
Contribution               $780
Labour Time              13 hours
Contribution per labour hour = Contribution per unit / lab hours per unit= 780/13 = 60 per hour
Hence the maximum overtime premium which the company can pay to keep the shop open after normal working hours is $60 per hour.

2). FOR LOVE SEATS
     Selling Price            $1360
     Variable cost           $1000
     Contribution             $360
     Labour hours             4 hrs
    Contribution per labour hr     = 360/4 = 90 per hr.

FOR RECLINER
Selling Price            $1280
Variable cost           $700
Contribution             $580
Labour hours            10 hrs
    Contribution per labour hr     = 580/10 = 58 per hr.
IF company offer to the nearby company to upholster furniture at the price of $45 per hour for love seats,there is the savings for which company can accept the offer and the time saved from this will contribute to the other seats which have higher contribution per labour hour i.e Sofa seats = 60 per lab hours
Net Benefit wil be = $60-$45 = $15 per hour

Yes, Tthe company should accept the offfer.