EcoLab sells a wide range of drums, bins, boxes, and other containers that are used in the chemical industry. One of the companys products is a heavy-duty corrosion-resistant metal drum, called the XYZ drum, used to store toxic wastes. Production is constrained by the capacity of an automated welding machine that is used to make precision welds. A total of 2,260 hours of welding time is available annually on the machine. Because each drum requires 0.4 hours of welding machine annual production is limited to 5,650 drums. At present, the welding machine is used exclusively to make the XYZ drums.

XYZ Drums
Selling price per drum		$ 201.00
Cost per drum:
Direct materials	$ 52.10
Direct labor ($29 per hour)	6.20
Manufacturing overhead	12.30
Selling and administrative expense	32.40	103.00
Margin per drum		$ 98.00

The accounting department has provided the following financial data concerning the XYZ drums: XYZ Drums Selling price per drum $ 201.00 Cost per drum: Direct materials $ 52.10 Direct labor ($29 per hour) 6.20 Manufacturing overhead 12.30 Selling and administrative expense 32.40 103.00 Margin per drum $ 98.00 Management believes 7,225 XYZ drums 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 drums from an outside supplier. DOW, a supplier of quality products, would be able to provide up to 4,650 XYZ-type drums per year at a price of $177 per drum, which EcoLab would resell to its customers at its normal selling price after appropriate relabeling.

Megan Flores, EcoLab production manager, has suggested that the company could make better use of the welding machine by manufacturing bike frames, which would require only 0.5 hours of welding machine time per frame and yet sell for far more than the drums. Megan believes that EcoLab could sell up to 1,860 bike frames per year to bike manufacturers at a price of $304 each. The accounting department has provided the following data concerning the proposed new product:

Bike Frames
Selling price per frame		$ 304.00
Cost per frame:
Direct materials	$ 107.20
Direct labor ($18 per hour)	49.60
Manufacturing overhead	49.00
Selling and administrative expense	58.20	264.00
Margin per frame		$ 40.00

The bike frames 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 XYZ drum and $1.90 per bike frame. The variable manufacturing overhead cost would not be incurred on drums 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 XYZ drum whether made or purchased and would be $2.0 per bike frame.

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 at EcoLab, 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 and has always been considered a variable cost at EcoLab. 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 just as strenuously that direct labor should be considered a fixed cost at EcoLab. No one had been laid off in over a decade, and for all practical purposes, everyone at the plant is on a monthly salary. 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 drums or frames, 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 bike frames would require.

Required (do this in excel, tables in 2-4 are there as a guide to help you. I would create the tables in excel)

1. Would you be comfortable relying on the financial data provided by the accounting department for making decisions related to the XYZ drums and bike frames?

2. Compute the contribution margin per unit for purchased XYZ drums, manufactured XYZ drums and manufactured bike frames. [assume direct labor is a fixed cost]

	Purchased XYZ Drums	Manufactured
		XYZ Drums	Bike Frames
Selling price
Variable costs:
Direct materials
Variable manufacturing overhead
Variable selling and administrative
Total variable cost
Contribution margin

3. Compute the contribution margin per welding hour for manufactured XYZ drums and bike frames. [assume direct labor is a fixed cost]

Manufactured
XYZ Drums		Bike Frames
Contribution margin per unit (above)
Welding hours per unit		hour		hour
Contribution margin per welding hour		per hour		per hour

4. Assuming direct labor is a fixed cost: a. Determine the number of XYZ drums (if any) that should be purchased and the number of XYZ drums and/or bike frames (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?