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 $1,005,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following.

	Chairs			Desks
Sales revenue	$	1,212,100		$	2,781,250
Direct materials		604,000			1,000,000
Direct labor		180,000			490,000

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 $850,000. 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?

Profit margin % for chairs?

Profit margin % for desks?

estimated margin for desks year 2?

Answer 1

Answer to a-1:-

Particulars   Chair Desk   Total

a) Sales Revenue $12,12,100 $27,81,250 $39,93,350

  Direct Material $6,04,000 $10,00,000 $16,04,000

Direct Labor $1,80,000 $4,90,000 $6,70,000

Overhead $2,70,000 $7,35,000 $10,05,000   

b) Product Cost $10,54,000 $22,25,000 $32,79,000

c) Profit(a-b) $1,58,100 $5,56,250 $7,14,350

Margin% (c/b) 15% 25%     21.78%

Answer to a-2:-

Chairs should be dropped as its Profit Margin is below 20%

Answer to b:-

Particulars      Desk Total

a) Sales Revenue    $27,81,250 $27,81,250

  Direct Material $10,00,000 $10,00,000

Direct Labor $4,90,000 $4,90,000

Overhead $8,50,000 $8,50,000   

b) Product Cost $23,40,000 $23,40,000

c) Profit(a-b)    $4,41,250 $4,41,250

Margin% (c/b) 18.85%   18.85%