Case: Utilization of a Constrained Resource

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 0.4 hours of welding machine time, annual production is limited to 5,000 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		$	149.00
Cost per drum:
Direct materials	$52.10
Direct labor ($18 per hour)	3.60
Manufacturing overhead	4.50
Selling and administrative expense	29.80		90.00
Margin per drum		$	59.00

Management believes 6,000 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 4,000 WVD-type drums per year at a price of $138 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 0.5 hours of welding machine time per frame and yet sell for far more than the drums. Megan believes that TufStuff could sell up to 1,600 bike frames per year to bike manufacturers at a price of $239 each. The accounting department has provided the following data concerning the proposed new product:

Bike Frames
Selling price per frame		$	239.00
Cost per frame:
Direct materials	$99.40
Direct labor ($18 per hour)	28.80
Manufacturing overhead	36.00
Selling and administrative expense	47.80		212.00
Margin per frame		$	27.00

The bike frames could be produced with existing equipment and personnel. Direct labor is a variable cost. 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 WVD 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 $0.75 per WVD drum whether made or purchased and would be $1.30 per bike frame.

Welding: As indicated earlier, the company has a welding machine that can give only 2,000 hours of welding time. Therefore, it is a constrained resource. Assume that the cost of using welding machine is fixed with respect to welding time. Direct labor: Direct labor cost is assumed to be variable. Required: 1. The margins of the two products are provided in the report submitted by the Accounting Department. Margin is computed by subtracting both variable and fixed costs from sales price. 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? 2. Compute the unit contribution margin for: a. Purchased WVD drums. b. Manufactured WVD drums. c. Manufactured bike frames. 3. Answer the following questions regarding WVD drums: a. What options are available to obtain WVD drums? b. How much is the opportunity cost of Make (manufacture) and Sell 1 WVD drum - rather than Buy (purchase) and Sell it? c. How much is UCM of manufactured XSX drum, net of opportunity cost? 4. Which product should be manufactured first? Why? 5. Determine a. the number units that should be manufactured (if any) and purchased (if any) for WVD drums. b. the number units that should be manufactured (if any) for bike frames. 5. Contribution margin from current operations (making 5,000 WVD drums only) generates a $456,000 contribution margin. Compute the improvement in total contribution margin that would result from this optimal decision (in #5) over current operations. 7. Exwelda is an outside company that rents welding machines. Exwelda charges its machine rental fee by the hour of welding machine time. What would be the highest price per hour of welding machine time that TufStuff, Inc. is willing to pay?