Type 5 Type 10 Type 20
Revenues $43,000 $49,000 $56,500
Variable cost $34,000 $28,000 $26,500
Fixed cost 8,000 8,000 8,000
Total cost $42,000 $36,000 $34,500
Income from operations $ 1,000 $13,000 $22,000
Number of units ÷ 5,000 ÷ 5,000 ÷ 5,000
Income from operations per unit $ 0.20 $ 2.60 $ 4.40
Mill’s operations require all three grades to be melted in a furnace before being formed. The furnace runs 24 hours a day, 7 days a week, and is a production bottleneck. The furnace hours required per unit of each product are as follows:
Type 5: 6 hours
Type 10: 6 hours
Type 20: 12 hours
The Marketing Department is considering a new marketing and sales campaign.
Which product should be emphasized in the marketing and sales campaign in order to maximize profitability?
Answer:
Determine the contribution margin per furnace hour as follows:
Type 5 Type 10 Type 20
Revenue……………………………………… $43,000 $49,000 $56,500
Variable cost………………………………… 34,000 28,000 26,500
Contribution margin……………………… $ 9,000 $21,000 $30,000
÷ Divide by number of units……………… 5,000 units 5,000 units 5,000 units
Unit contribution margin………………… $ 1.80 $ 4.20 $ 6.00
Unit contribution margin
per furnace hour*………………………… $ 0.30 $ 0.70 $ 0.50
* Calculated as follows:
$1.80
Type 5: = $0.30 per furnace hour
6 hours
$4.20
Type 10: = $0.70 per furnace hour
6 hours
$6.00
Type 20: = $0.50 per furnace hour
12 hours
Emphasize Type 10. In a production-constrained environment, Type 10 generates
the most unit contribution margin per hour of furnace resource and, thus, is the
most profitable. While Type 20 has the largest profit per unit ($4.40) and unit
contribution margin ($6.00), these would not be the correct metrics for determining
the product to emphasize in the marketing campaign, assuming the furnace is a
bottleneck resource.
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