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 constraint) 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	$	1,376		$	1,850		$	1,425
Variable cost per unit	$	800		$	1,300		$	1,050
Upholstery labor-hours per unit	9 hours			10 hours			5 hours

Required:

1. Portsmouth is considering paying its upholstery laborers hourly compensation, in addition to their usual salaries, 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 $49 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 if it hires the nearby upholstering company to make Love Seats?

3. Should Portsmouth hire the nearby upholstering company?

Answer 1

Solution - 1:

Selling price of sofa = $1,850

Variable cost per unit of Sofa = $1,300

Contribution per unit of Sofa = $1,850 - $1,300 = $550

Time required to produce one unit of Sofa = 10 hours

Contribution per hour of Sofa = 550/10 = $55/Hour

If upholstery shops keep open after normal working hours, we can pay maximum overtime premium of $55 per hour that will result in no profit no loss.

Solution – 2:

Selling price per unit of love seat = $1,425

Variable cost per unit of love seat = $1050

Contribution per unit of love seat = $1,425 - $1050 = $375

Time required to produce one unit of love seat = 5 hours

Contribution per hour of love seat = 375/5 = $75/Hour

If job will be given to upholstering company then charges payable = $49/hour

Additional contribution margin per hour if we hire upholstering company to upholster the love seat = $75 - $49 = $26/Hour

Solution – 3:

As Portsmouth is earning additional contribution of $26/hour by hiring nearby company; therefore it should hire nearby upholster company.