TufStuff, Incorporated, sells a wide range of drums, bins, boxes, and other containers that are used in the chemical

industry. One of the company's 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 $2,020$ hours of welding time is available annually on the machine. Because each drum

requires $0\mathrm{.}4$ hours of welding machine time, annual production is limited to $5,050$ 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:

Management believes $6,025$ 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, Incorporated, a supplier of quality products, would be able to provide up to $4,050$

WVD$-$type drums per year at a price of $$141$ per drum, which TufStuff would resell to its customers at its normal selling

price after appropriate relabeling.

Megan Flores, TufStuff's production manager, has suggested that the company could make better use of the welding

machine by manufacturing bike frames, which would require only $0\mathrm{.}5$ hours of welding machine time per frame and yet

sell for far more than the drums. Megan believes that TufStuff could sell up to $1,620$ bike frames per year to bike

manufacturers at a price of $$244$ each. The accounting department has provided the following data concerning the

proposed new product:

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

$$1\mathrm{.}35$ per WVD drum and $$1\mathrm{.}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 $$\mathrm{.}75$ per WVD drum whether made or purchased and would be $$1\mathrm{.}40$ per bike frame.

All of the company's employees$-$direct and indirect$-$are paid for full $40\mathrm{.}00-$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 TufStuff, 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

TufStuff. 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 TufStuff. 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 $40\mathrm{.}00-$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:

Would you be comfortable relying on the financial data provided by the accounting department for making decisions

related to the WVD drums and bike frames?

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

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

Assuming direct labor is a fixed cost:

a$.$ Determine the number of WVD drums $($if any$)$ that should be purchased and the number of WVD 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?

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

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

Assuming direct labor is a variable cost:

a$.$ Determine the number of WVD drums $($if any$)$ that should be purchased and the number of WVD drums and$/$or bike

frames $($if any$)$ that should be