Question

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6 P8-6A. Product Emphasis Lowell Corporation manufactures both a deluxe and a standard model of ousehold food blender. Because of limited demand, for several years production has been at 80% of estimated capacity, which is thought to be limited by the number of machine hours available. At ou rent operation levels, a profit analysis for each product line shows the following data: Per-Unit Data Deluxe Standard Sales price Production costs $216 $84 $89 36 15 25 $%165 10$56 $12 23 Direct labor. . .. 18 10 Fixed operating expenses .. 71 $191 $ 25 $13 Assigned on the basis of machine hours at normal capacity. Management wants to utilize the company's current excess capacity by increasing production. Required a. What general decision guideline applies in this situation? Assuming that sufficient units of either product can be sold at current prices to use exist capacity fully and that total fixed cost will not be affected, prepare an analysis showing w product line should be emphasized if net income for the firm is the decision basis. hich

Answer 1

Solution

Lowell Corporation

1. General decision guidelines that apply in the given situation –

Cost-benefit approach is the general decision guideline applied in the strategic decision making of using the excess capacity to the product that provides maximum profitability. The emphasis is on costs that have an impact on the decision. All the fixed costs including manufacturing and selling overheads are regarded as irrelevant as these costs remain constant throughout the given estimated capacity. Also, the fixed costs are sunk costs that are incurred regardless of level of operating capacity. Hence, the emphasis is on direct or variable costs, which remain constant at unit level and have impact on the profitability.

2. Analysis to determine which product line should be emphasized if net income for the firm is the decision basis:

Lowell Corporation
Cost-Benefit Analysis
	Per - Unit
Product	Deluxe	Standard
Sales price	$216	$84
Variable costs:
Direct Material	$89	$12
Direct labor	$36	$23
Manufacturing overhead	$15	$11
operating expenses	$18	$10
Total variable cost	$158	$56
Contribution Margin	$58	$28

This analysis indicates that Deluxe product earns higher contribution margin per unit.

Hence, production of Deluxe using excess capacity maximizes net income for the firm.

The higher contribution margin of Deluxe would absorb the fixed overhead costs and result in higher profitability.