Question

Exercise 6-8 (Algo) Volume Trade-Off Decisions [LO6-5, LO6-6]

Barlow Company manufactures three products—A, B, and C. The selling price, variable costs, and contribution margin for one unit of each product follow:
Product
A B C
Selling price $160 $270 $210 Variable expenses: Direct materials 16 80 24 Other variable expenses 108 90 144 Total variable expenses 124 170 168 Contribution margin $36 $100 $42 Contribution margin ratio 23 % 37% 20 %
The same raw material is used in all three products. Barlow Company has only 5,700 pounds of raw material on hand and will not be able to obtain any more of it for several weeks due to a strike in its supplier’s plant. Management is trying to decide which product(s) to concentrate on next week in filling its backlog of orders. The material costs $8 per pound.
Required:
1. Calculate the contribution margin per pound of the constraining resource for each product.
2. Assuming that Barlow has unlimited demand for each of its three products, what is the maximum contribution margin the company can earn when using the 5,700 pounds of raw material on hand?
3. Assuming that Barlow’s estimated customer demand is 500 units per product line, what is the maximum contribution margin the company can earn when using the 5,700 pounds of raw material on hand?
4. A foreign supplier could furnish Barlow with additional stocks of the raw material at a substantial premium over the usual price. Assuming Barlow’s estimated customer demand is 500 units per product line and that the company has used its 5,700 pounds of raw material in an optimal fashion, what is the highest price Barlow Company should be willing to pay for an additional pound of materials?

Answer 1

To calculate the contribution margin per pound of the constraining resource for each product, divide the contribution margin by the variable expense for direct materials. The maximum contribution margin Barlow Company can earn using the available raw material is the sum of the contribution margin per pound multiplied by the available pounds of raw material for each product. If the estimated customer demand is 500 units per product line, the maximum contribution margin is calculated by multiplying the estimated demand by the contribution margin per unit for each product and then dividing by the direct materials variable expense per pound. The highest price Barlow Company should be willing to pay for an additional pound of materials is the additional contribution margin earned divided by the increased variable expense for materials.

Step-by-step explanation:

To determine the contribution margin per pound of the constraining resource for each product, we divide the contribution margin by the variable expense for direct materials. For product A, the contribution margin per pound is $36 / $16 = $2.25. For product B, it is $100 / $80 = $1.25. And for product C, it is $42 / $24 = $1.75.

If Barlow Company has only 5,700 pounds of raw material on hand, the maximum contribution margin it can earn is the sum of the contribution margin per pound multiplied by the available pounds of raw material for each product. For product A, it is $2.25 * 5700 = $12,825. For product B, it is $1.25 * 5700 = $7,125. And for product C, it is $1.75 * 5700 = $9,975. Hence, the maximum contribution margin the company can earn is $12,825 + $7,125 + $9,975 = $29,925.

If Barlow Company's estimated customer demand is 500 units per product line, the maximum contribution margin it can earn when using the 5,700 pounds of raw material on hand is calculated by multiplying the estimated demand by the contribution margin per unit for each product and then dividing by the direct materials variable expense per pound. For product A, it is (500 * $36) / $16 = $1,125. For product B, it is (500 * $100) / $80 = $625. And for product C, it is (500 * $42) / $24 = $875. Therefore, the maximum contribution margin the company can earn is $1,125 + $625 + $875 = $2,625.

To determine the highest price Barlow Company should be willing to pay for an additional pound of materials, we calculate the additional contribution margin the company would earn from using that pound and divide it by the increased variable expense for materials. Assuming the company has used its 5,700 pounds of raw material in an optimal fashion, the additional contribution margin for product A would be $36, for product B would be $100, and for product C would be $42. Therefore, the highest price the company should be willing to pay for an additional pound of materials is $36, $100, and $42 for products A, B, and C respectively.