Humbolt Electric manufactures electronic subcomponents that be sold at the end of Process #1 or processed further, in Process #2, and then sold. Currently, the entire output of Process #1 can be sold at a price of $2 per unit. The output of Process #2 has in the past sold for $5.50 per unit; however, the price of this output has recently dropped to $5.10 (on average).

On the basis of an analysis of the above cost and selling price information, as well as an analysis of market trend-data, the VP of Marketing has suggested that output from Process #2 should be curtailed whenever the price of its output falls below $4.50 per unit. The VP of Manufacturing has indicated that the total available capacity is interchangeable between the two processes. (That is, fixed manufacturing costs are largely independent of decisions regarding short-term product mix.) He recommends that, based on current prices, all sales should be from Process #2 output. His analysis follows:

Direct materials and direct labor are variable costs. All manufacturing overhead costs are fixed and are allocated to units produced based on hours of capacity used.
Total hours of capacity available are 600,000. The products are produced in batches of 60 units. Each batch of output from Process #1 requires one hour of processing; each batch of output from Process #2 requires two additional hours of processing.
Required
1. Develop a schematic diagram of the two-stage production process. Include in your diagram relevant revenue (selling price per unit) as well as relevant costs (per unit of output).
2. If the price of the output from Process #2 for the coming year is expected to be $5.10, should all sales be only from Process #2, as asserted by the VP of manufacturing?

3. What is the lowest acceptable price for the output from Process #2 to make it as profitable as the output from Process #1?
4. Suppose that 50% of the manufacturing overhead costs are variable. Do your answers to parts 1 and 2 above change? If so, why?
5. Sensitivity analysis: Calculate the contribution margin per processing hour for both Process #1 output and Process #2 output under each of the following assumptions regarding the percentage of variable overhead cost: 0%, 25%, 50%, and 100%. Perform these calculations for Process #2 output both for a selling price of $5.10 per unit and a selling price of $5.50 per unit. What general conclusion can you draw on the basis of this sensitivity analysis?

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Output of Process #1 Output of Process #2 Selling price, after deducting selling-related costs S2.00 $5.10 Costs: Direct materials (DM) Direct labor (DL) Manufacturing overhead Transferred-in variable costs from 1.00 0.20 0.60 1.50 0.40 1.20 Process #1 (DM + DL) N/A S0.20 1.20 S0.80 Operating profit