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 constriant) 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	$	1,162		$	1,885		$	1,475
Variable cost per unit	$	850		$	1,300		$	1,100
Upholstery labor-hours per unit	6 hours			13 hours			5 hours

Required:

1. Portsmouth is considering paying its upholstery laborers additional compensation 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 $42 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 it hires the nearby upholstering company to make Love Seats?

3. Should Portsmouth hire the nearby upholstering company?

Answer 1

1). Here we have to calculate the contribution margin per hour of upholstery time for sofa, which is going to be the maximum amount which can be paid by company for working after normal hours.

Hence maximum amount payable per hour is $45, because at this rate there will be breakeven for the company if working is done after normal hours.

2). Here we have to calcualte the contribution margin per hour of upholstery time for Love seats.

Additional contribution margin per hour can Portsmouth earn if it hires the nearby upholstering company to make Love Seats is $75 - $42 = $33 per hour.

3). Yes, management should accept this offer because the contribution margin per hour of love seat is $75 and if it accepts this offer, the company will pay only $42 per hour which makings its savings of $33 per hour and use its own time for production of other units of products.