Benoit Company produces three products—A, B, and C. Data concerning the three products follow (per unit):
Product
| |||||||||||
| A | B | C | |||||||||
| Selling price | $ |
85.00
| $ | 60.00 | $ | 82.00 | |||||
| Variable expenses: | |||||||||||
| Direct materials | 27.20 | 15.00 | 8.00 | ||||||||
| Other variable expenses | 27.20 | 33.00 | 53.50 | ||||||||
| Total variable expenses | 54.40 | 48.00 | 61.50 | ||||||||
| Contribution margin | $ | 30.60 | $ | 12.00 | $ | 20.50 | |||||
| Contribution margin ratio | 36 | % | 20 | % | 25 | % | |||||
The company estimates that it can sell 850 units of each product per month. The same raw material is used in each product. The material costs $4 per pound with a maximum of 5,100 pounds available each month.
Required:
1. Calculate the contribution margin per pound of the constraining resource for each product.
2. Which orders would you advise the company to accept first, those for A, B, or C? Which orders second? Third?
3. What is the maximum contribution margin that the company can earn per month if it makes optimal use of its 5,100 pounds of materials?
Explanation
1.
The contribution margin per pound of the constraining resource for each product is computed as follows:
| Product A | Product B | Product C | ||||||||
| (1) | Direct materials required per unit | $ | 27.20 | $ | 15.00 | $ | 8.00 | |||
| (2) | Cost per pound | $ | 4 | $ | 4 | $ | 4 | |||
| (3) | Pounds required per unit (1) ÷ (2) | 6.80 | 3.75 | 2.00 | ||||||
| (4) | Contribution margin per unit | $ | 30.60 | $ | 12.00 | $ | 20.50 | |||
| (5) | Contribution margin per pound of materials used (4) ÷ (3) | $ | 4.50 | $ | 3.20 | $ | 10.25 | |||
2.
The company should accept orders first for Product C, second for Product A, and third for Product B.
Because Product C uses the least amount of material per unit of the three products, and because it is the most profitable of the three in terms of its use of materials, some students will immediately assume that this is an infallible relationship. That is, they will assume that the way to spot the most profitable product is to find the one using the least amount of the constrained resource. The way to dispel this notion is to point out that Product A uses more material (the constrained resource) than Product B, but yet it is preferred over Product B. The key factor is not how much of a constrained resource a product uses, but rather how much contribution margin the product generates per unit of the constrained resource.
3.
If customer demand is limited to 850 units per product the maximum contribution margin of $32,725 is computed as follows:
A | B | C | Total | |||||||||
| Contribution margin per pound (above) | $ | 4.50 | $ | 3.20 | $ | 10.25 | ||||||
| Pounds of material used | × | 3,400 | × | 0 | × | 1,700 | ||||||
| Total contribution margin | $ | 15,300 | $ | 0 | $ | 17,425 | $ | 32,725 | ||||
Product C would be produced first because it earns the highest contribution margin per pound. Given that Product C has customer demand of 850 units, it would consume 1,700 pounds of material (=850 units × 2.00 pounds per unit). Product A, which also has customer demand of 850 units, would be produced next because it has the second highest contribution margin per pound. It would consume the remaining 3,400 pounds of material (=500 units × 6.80 pounds per unit). Since Products C and A consume a total of 5,100 pounds of material (1,700 pounds + 3,400 pounds), it leaves zero pounds available for making the least profitable product, which is Product B.
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