Question

TufStuff, Inc., sells a wide range of drums, bins, boxes, and other containers that are used in the chemical Industry. One of the company's products is a heavy-duty corrosion-resistant metal drum, called the WVD drum, used to store toxic wastes. Production is constrained by the capacity of an automated welding machine that is used to make precision welds. A total of 2.380 hours of welding time is available annually on the machine. Because each drum requires 0.4 hours of welding machine time, annual production is limited to 5,475 drums. At present, the welding machine is used exclusively to make the WVD drums. The accounting department has provided the following financial data concerning the WVD drums: $225.00 WVD Drums Selling price per drum Cost per drum: Direct materials Direct labor ($37 per hour) Manufacturing overhead Selling and administrative expense Margin per drum $52.10 7.40 15.90 33.60 109.00 $116.00 Management believes 7,375 WVD drums could be sold each year if the company had sufficient manufacturing capacity. As an alternative to adding another welding machine, management has considered buying additional drums from an outside supplier. Harcor Industries, Inc., a supplier of quality products, would be able to provide up to 4,475 WVD type drums per year at a price of $195 per drum, which TutStuff would resell to its customers at its normal selling price after appropriate relabeling Megan Flores, TufStuff's production manager, has suggested the company could make better use of the welding machine by manufacturing bike frames, which would require only 0.5 hours of welding machine time per frame and yet sell for far more than the drums, Megan believes that TufStuff could sell up to 1,980 bike frames per year to bike manufacturers at a price of $334 each. The accounting department has provided the following data concerning the proposed new product

Answer 1

	Assuming direct labor is a variable cost
1	Contribution margin per unit:
					Purchased WVD drums	Manufactured WVD drums	Manufactured Bike frames
	Selling price			a	225	225	334
	Less; Variable costs
	Materials				195	52.1	110.8
	Direct labor				0	7.4	59.2
	Variable manufacturing overhead				0	1.35	1.9
	Variable selling and administrative				0.75	0.75	3.2
	Total variable cost			b	195.75	61.6	175.1
	Contribution margin per unit			(a-b)	29.25	163.4	158.9
	Contribution margin per welding hour:
					Manufactured WVD drums	Manufactured Bike frames
	Contribution margin per unit			a	163.4	158.9
	Welding hours per unit			b	0.4	0.5
	Contribution margin per welding hour (a/b)				408.5	317.8
	Ranking of alternatives based on contribution margin per hour:
					Manufactured WVD drums	Manufactured Bike frames
	Contribution margin per welding hour (a/b)				408.5	317.8
	Rank				1	2
	Preference should be given to manufacturing WDV drums
	Total hours available=2380 hours
	Demand for WDV drums=7375 drums
	Welding hours per unit=0.40
	WDV drums using 2380 hours=2380/0.40=5950 drums
	Rest of the drums can be purchased from outside
	Drums to be purchased=7375-5950=1425 drums
	No bike frame can be produced since, there is no welding hours available
			Purchased	Manufactured
	WVD drums		1425	5950
	Bike frames			0
	Increase in net operating income:
					Units	Contribution margin per unit	Total contribution
	Manufactured WVD drums				5950	163.4	972230
	Purchased WVD drums				1425	29.25	41681.25
	Total						1013911.25
	Less: Current contribution margin				5475	116	635100
	Increase in net operating income						378811
2	Assuming direct labor is a fixed cost,
	Contribution margin per unit:
					Purchased WVD drums	Manufactured WVD drums	Manufactured Bike frames
	Selling price			a	225	225	334
	Less; Variable costs
	Materials				195	52.1	110.8
	Direct labor				0	0	0
	Variable manufacturing overhead				0	1.35	1.9
	Variable selling and administrative				0.75	0.75	3.2
	Total variable cost			b	195.75	54.2	115.9
	Contribution margin per unit			(a-b)	29.25	170.8	218.1
	Contribution margin per welding hour:
					Manufactured WVD drums	Manufactured Bike frames
	Contribution margin per unit			a	170.8	218.1
	Welding hours per unit			b	0.4	0.5
	Contribution margin per welding hour (a/b)				427	436.2
	Ranking of alternatives based on contribution margin per hour:
					Manufactured WVD drums	Manufactured Bike frames
	Contribution margin per welding hour (a/b)				427	436.2
	Rank				2	1
	Preference should be given to manufacturing bike frames
	Total hours available=2380 hours
	Demand for Bike frames=1980 frames
	Welding hours per unit=0.50
	Welding hours used for bike frames=1980*0.50=990 hours
	Balance welding hours available=2380-990=1390 hours
	Welding hours per unit for WVD drums=0.40
	Drums can be produced=1390/0.40=3475 Drums
	Demand for WDV drums=7375 drums
	Rest of the drums can be purchased from outside
	Drums to be purchased=7375-3475=3900 drums
			Purchased	Manufactured
	WVD drums		3900	3475
	Bike frames		0	1980
	Increase in net operating income:
					Units	Contribution margin per unit	Total contribution
	Manufactured WVD drums				3475	170.8	593530
	Purchased WVD drums				3900	29.25	114075
	Bike frames produced				1980	218.1	431838
	Total						1139443
	Less: Current contribution margin				5475	116	635100
	Increase in net operating income						504343