Analyzing Decisions for TufStuff, Inc.: Maximizing Profitability
Question 1:
Why would including fixed costs in the margin per drum and margin per frame be a problem in analyzing the decisions that TufStuff, Inc. is contemplating?
Question 2:
Compute the contribution margin per unit for (a) Purchased WVD drums, (b) Manufactured WVD drums, and (c) Manufactured bike frames assuming direct labor is a fixed cost?
Question 3:
Compute the contribution margin per welding hour for (a) Manufactured WVD drums and (b) Manufactured bike frames assuming direct labor is a fixed cost?
Question 4:
Determine the number of WVD drums to be purchased and the number of WVD drums and/or bike frames to be manufactured. What is the increase (decrease) in net operating income compared to the current operations?
Question 5:
How would treating direct labor as a variable cost change the decision regarding the number of WVD drums to be purchased and the number of WVD drums and/or bike frames to be manufactured?
Answer:
Explanation:
The problem with including fixed costs in the calculation of margin per drum and margin per frame is that it can lead to inaccurate decision-making. Fixed costs are not affected by the quantity of units produced, so including them in the margin calculation can make it seem like certain products are more profitable than they actually are. By excluding fixed costs, the company can get a clearer picture of the profitability of each unit.
Answer to Question 2:
For purchased WVD drums, the contribution margin per unit would be the selling price of $138 per drum. For manufactured WVD drums and bike frames, the contribution margin per unit would be the selling price minus the variable costs.
Answer to Question 3:
For manufactured WVD drums and bike frames, the contribution margin per welding hour would be the selling price minus the variable costs divided by the welding machine time required per unit.
Answer to Question 4:
The decision on the number of units to purchase or manufacture should be based on maximizing net operating income. The increase or decrease in net operating income can be calculated by multiplying the difference in contribution margin by the number of units produced or sold.
Answer to Question 5:
Treating direct labor as a variable cost would impact the contribution margin per unit and per welding hour. This could change the decision on the number of units to purchase or manufacture. The decision should still focus on maximizing net operating income.
When analyzing decisions for TufStuff, Inc., it is crucial to consider variable costs and exclude fixed costs from margin calculations to ensure accurate decision-making. By computing contribution margins per unit and per welding hour, the company can gain insight into the profitability of each product option.
Including fixed costs in margin calculations can distort the true profitability of products as fixed costs do not change with production quantities. Therefore, it is essential to focus on variable costs that directly impact production and sales.
To determine the contribution margin per unit, the selling price should be subtracted from the variable costs for each product option. This calculation provides a clearer view of the profitability of purchased WVD drums, manufactured WVD drums, and manufactured bike frames.
Calculating the contribution margin per welding hour further refines the analysis by considering the time and costs associated with the welding machine. This calculation helps in comparing the profitability of manufacturing WVD drums and bike frames based on welding machine utilization.
The decision on the number of units to purchase or manufacture should be based on maximizing net operating income. By comparing the contribution margins and considering the production capacity constraints, TufStuff, Inc. can identify the most profitable product mix.
If direct labor is treated as a variable cost, recalculating the contribution margins is necessary as it can impact the decision-making process. Adjusting for direct labor as a variable cost can change the profitability analysis and influence the number of units to purchase or manufacture.