A company sells a wide range of storage solutions used in the production and disposal of nuclear energy. One of the companys products is a metal drum built to withstand over 200 years of toxic waste. Production is constrained by the capacity of a welding machine used to make the exacting welds required for long-term storage. A total of 2,000 hours of welding time is available annually on the machine. Because each drum requires 0.5 hours of welding machine time, annual production is limited to 4,000 barrels. At present, the welding machine is only used to make the barrels. The accounting department has provided the following related financial data:

Barrels
Selling Price Per Drum		$201
Cost per drum
Direct Materials	$63
Direct Labor ($20 per hour)	$5
Manufacturing Overhead	$8
Selling & Admin Expense	$35.40	$111.40
Margin per drum		$88.60

Management believes 6,000 barrels could be sold each year if the company had sufficient manufacturing capacity. As an alternative to adding another welding machine, management has considered buying additional barrels from an outside supplier. Purchasing has located a vendor who would supply up to 2,500 barrels per year at a price of $144 per drum, which the original company would relabel and resell to its customers at its normal selling price.

The companys production manager, has suggested that the company could make better use of the welding machine by manufacturing industrial shelving units, which would require only 0.25 hours of welding machine time per unit and sell for more than the barrels. The production manager believes the company could sell up to 2,000 shelving units per year to other manufacturers at a price of $160 each. The accounting department has provided the following data concerning the proposed new product:

Shelving Units
Selling price per unit		$220
Cost per unit
Direct Materials	$92.60
Direct labor ($20 per hour)	$5
Manufacturing Overhead	$38
Selling & Admin Expense	$49.40	$185
Margin per drum		$34

The shelving units could be produced with existing equipment and personnel. Manufacturing overhead is allocated to products on the basis of direct labor-hours. Most of the manufacturing overhead consists of fixed common costs such as rent on the factory building, but some of it is variable. The variable manufacturing overhead has been estimated at $1.35 per barrel and $1.90 per shelving unit. The variable manufacturing overhead cost would not be incurred on barrels acquired from the outside supplier.

Selling and administrative expenses are allocated to products on the basis of revenues. Almost all of the selling and administrative expenses are fixed common costs, but it has been estimated that variable selling and administrative expenses amount to $.75 per barrel whether made or purchased and would be $1.50 per shelving.

All of the companys employeesdirect and indirectare paid for full 40.00-hour work weeks and the company has a policy of laying off workers only in major recessions.

As soon as your analysis was shown to the top management team, several managers got into an argument concerning how direct labor costs should be treated when making this decision. One manager argued that direct labor is always treated as a variable cost in textbooks and in practice. After all, direct means you can directly trace the cost to products. If direct labor is not a variable cost, what is? Another manager argued direct labor should be considered a fixed cost at the company since no one has been laid off in the past 10 years. Everyone classified as direct labor works a regular 40.00-hour workweek and overtime has not been necessary since the company adopted Lean Production techniques. Whether the welding machine is used to make barrels or shelving units, the total payroll would be exactly the same. There is enough slack, in the form of idle time, to accommodate any increase in total direct labor time that the shelves would require.

Required:

1. Compute the contribution margin per unit. [assume direct labor is a fixed cost]

2. Compute the contribution margin per welding hour. [assume direct labor is a fixed cost]

3. Assuming direct labor is a fixed cost: a. Determine the number of barrels (if any) that should be purchased and the number of barrels and/or shelving units (if any) that should be manufactured. b. What is the increase (decrease) in net operating income that would result from this plan over current operations?

4. Compute the contribution margin per unit. [assume direct labor is a variable cost]

5. Compute the contribution margin per welding hour. [assume direct labor is a variable cost]

6. Assuming direct labor is a variable cost: a. Determine the number of barrels (if any) that should be purchased and the number of barrels and/or shelves (if any) that should be manufactured. b. What is the increase (decrease) in net operating income that would result from this plan over current operations?