Case Study: Storage Systems, Inc.

1. The given margins of the two products as indicated in the reports submitted by the accounting department for the drums and mountain bike frames should not be used in the decision of which product to make. This is due to the following reasons:

a. The product margins are lower than they should be, simply due to the fact of the presence of allocated common fixed costs that happen to be irrelevant in making this decision.

b. Moreover, when the fixed costs are taken out of the equation, the profitability of the two products is of more relevance as compared to the amount of the welding time that they use. A product with a very low margin may be desirable in a situation that it is more efficient in using the constrained resource, welding hours in this case.

2. Objective: To compute Contribution Margin per unit.

The fact that "All the company's employees - direct and indirect - are paid for full 40-hour workweeks" strongly indicates that the direct labor is an entirely fixed cost (i.e., it has no variable component, since the employees get paid for 40 hors per week no matter how much they work).

Purchased XSX drums Manufactured XSX drums Manufactured Mountain Bike Frames

Selling Price $ 154.00 $ 154.00 $ 65.00

Variable Cost per Unit:

Materials $ 120.00 $ 44.50 $ 17.50

Manufacturing Overhead $ - $ 1.05 $ 0.60

Selling and Administrative Cost $ 0.85 $ 120.85 $ 0.85 $ 46.40 $ 0.40 $ 18.50

Contribution Margin per unit $ 33.15 $ 107.60 $ 46.50

Welding hours per unit 0.80 0.20

Contribution margin per unit per welding hour $ 134.50 $ 232.50

3.

Quantity

(1) Contribution Margin/Unit (2) Welding Time

per Unit

(3) Total Welding Time

(4) = (1)Ч(3) Welding Time Available (5) Total Contribution Margin (6) = (2)Ч(1)

Total hours available 2000

Mountain bike frames manufactured 3500 46.50 0.2 700 1300 162750

XSX Drums--make 1625 107.60 0.8 1300 0 174850

XSX Drums--buy 1375 33.15 45581.25

Total contribution margin 383,181.25

Less: Contribution Margin @ Status quo 269,000.00

Increase in Contribution Margin $114,181.25

4. Assuming the opposite of the previous assumption (i.e., the direct labor is a variable cost)

Purchased XSX drums Manufactured XSX drums Manufactured Mountain Bike Frames

Selling Price $ 154.00 $ 154.00 $ 65.00

Variable Cost per Unit:

Materials $ 120.00 $ 44.50 $ 17.50

Direct Labour $ - $ 4.50 $ 22.50

Manufacturing Overhead $ - $ 1.05 $ 0.60

Selling and Administrative Cost $ 0.85 $ 120.85 $ 0.85 $ 50.90 $ 0.40 $ 41.00

Contribution Margin per unit $ 33.15 $ 103.10 $ 24.00

Welding hours per unit 0.80 0.20

...