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case7

TufStuff, Inc., 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 WVD 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 2,000 hours of welding time is available annually on the machine. Because each drum requires 0.8 hours of welding machine time, annual production is limited to 2,500 drums. At present, the welding machine is used exclusively to make the WVD drums. The accounting department has provided the following financial data concerning the WVD drums:

WVD Drums
Selling price per drum		$	165.00
Cost per drum:
Direct materials	$45.10
Direct labor ($18 per hour)	4.50
Manufacturing overhead	3.75
Selling and administrative expense	16.00		69.35
Margin per drum		$	95.65

Management believes 3,000 WVD 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. Harcor Industries, Inc., a supplier of quality products, would be able to provide up to 1,800 WVD-type drums per year at a price of $140 per drum, which TufStuff would resell to its customers at its normal selling price after appropriate relabeling.

Megan Flores, TufStuffs production manager, has suggested that the company could make better use of the welding machine by manufacturing bike frames, which would require only 0.2 hours of welding machine time per frame and yet sell for far more than the drums. Megan believes that TufStuff could sell up to 3,500 bike frames per year to bike manufacturers at a price of $71 each. The accounting department has provided the following data concerning the proposed new product:

Bike Frames
Selling price per frame		$	71.00
Cost per frame:
Direct materials	$18.10
Direct labor ($18 per hour)	22.50
Manufacturing overhead	16.35
Selling and administrative expense	7.10		64.05
Margin per frame		$	6.95

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 $1.11 per WVD drum and $1.20 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 $0.91 per WVD drum whether made or purchased and would be $1.00 per bike frame.

All of the companys employeesdirect and indirectare paid for full 40-hour workweeks and the company has a policy of laying off workers only in major recessions.

2. Compute the contribution margin per unit for [assume direct labor is a fixed cost]: (Do not round intermediate calculations. Round your answers to 2 decimal places.) . Purchased WWD drum b. Manufactured WO drums c. Manufsctured bike frames per unit per unit 3. As soon as your analysis was shown to the top mansgement team at Tufstuft, several managers got into an argument conceming how directlabor costs should be trested when making this decision. One mansger argued tha! direct labor is slways treated as a variable cost in textbooks and in practice and has always been considered a variable cost at Tufstuff. Afler all, direet" means you can directly trace the cost to produets. "lf direct labor is not a variable cost, what is? Anather manager argued just as strenuously that direct labor should be considered a fixed cost at TufStuff. No ane had been laid off in over a decade, and for all practical purposes, everyone a! the plant is an a monthly salary. Everyone classified as direct labor works a regular 40-hour workweek and overtime has not been necessary since the company adopted Lean Praduction techniques. Whether the welding machine is used to make drums ar frames, the tatal payrol 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 Compute the contribution margin per welding hour for lessume direct labor is fixed cost : (Round your final answers to2 decimal places.) Manufaetured wVD drum per hour Manufactured b ke frame: b. Determine the number of wVD drums (if any) thst should be purchased and the number ot WWD drums andior bike frames (if any) thst should be manufactured. [Assume direct labor is a fixed cost WWD drums Bike frames c. What is the increase in net operating income that would result rom this plan over current operations? (Do not round intermediate calculations.)