Question

McNulty, Inc., produces desks and chairs. A new CFO has just been hired and announces a new policy that if a product cannot earn a margin of at least 20 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost. Manufacturing overhead for year 1 totaled $645.000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following. Sales revenue Direct materials Direct labor Chairs $1,046,500 585,000 130,000 Desks $1,950,000 810,000 300,000 Required: a-1. Based on the CFO's new policy, calculate the profit margin for both chairs and desks. a-2. Which of the two products should be dropped? b. Regardless of your answer in requirement (a), the CFO decides at the beginning of year 2 to drop the chair product. The company cost analyst estimates that overhead without the chair line will be $660,000. The revenue and costs for desks are expected to be the same as last year. What is the estimated margin for desks in year 2?

Answer 1

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a - 1		Profit Margin
	Chairs	15%
	Desks	25%
a - 2	Chairs
	As Chairs gives less profit margin
b.	Estimated margin for desks - Year 2	10%
	Workings:
a - 1		Chairs	Desks
(i)	Sales Revenue	$       10,46,500	$       19,50,000
	Direct material	$          5,85,000	$          8,10,000
	Direct labor	$          1,30,000	$          3,00,000
	Overhead	$          1,95,000	$          4,50,000
(ii)	Total cost	$          9,10,000	$       15,60,000
(iii) = (i) - (ii)	Gross Profit	$          1,36,500	$          3,90,000
(iii) / (ii)	Profit Margin	15%	25%
		Chairs	Desks	Total
(i)	Direct labor	$          1,30,000	$          3,00,000	$ 4,30,000
(ii) = (i) / $430000	Weight	30%	70%
(ii) X $645000	Overhead	$          1,95,000	$          4,50,000	$ 6,45,000
b.		Desks
(i)	Sales Revenue	$       19,50,000
	Direct material	$          8,10,000
	Direct labor	$          3,00,000
	Overhead	$          6,60,000
(ii)	Total cost	$       17,70,000
(iii) = (i) - (ii)	Gross Profit	$          1,80,000
(iii) / (ii)	Profit Margin	10%