Barlow Company manufactures three products: A, B, and C. The selling price, variable costs, and contribution margin for one unit of each product follow: Product $210 $320 $240 Selling price Variable expenses: 16 64 24 Direct materials Other variable expenses 132 110 96 126 156 Total variable expenses 160 84 $160 84 Contribution margin 40% 50% Contribution margin ratio 35% The same raw material is used in all three products. Barlow Company has only 5,700 pounds of raw material on hand and will not be able to obtain any more of it for several weeks due to a strike in its supplier’s plant. Management is trying to decide which product(s) to concentrate on next week in filling its backlog of orders. The material costs $8 per pound.
The Correct Answer and Explanation is :
To determine which product Barlow Company should prioritize given the limited raw material, we need to calculate the contribution margin per pound of raw material for each product. This metric indicates how much profit each product generates per pound of raw material used.
Step 1: Calculate Contribution Margin per Unit
The contribution margin per unit is the selling price minus the total variable expenses.
- Product A:
- Selling Price: $210
- Variable Expenses: $16 (Direct Materials) + $132 (Other Variable Expenses) = $148
- Contribution Margin per Unit: $210 – $148 = $62
- Product B:
- Selling Price: $320
- Variable Expenses: $64 (Direct Materials) + $110 (Other Variable Expenses) = $174
- Contribution Margin per Unit: $320 – $174 = $146
- Product C:
- Selling Price: $240
- Variable Expenses: $24 (Direct Materials) + $96 (Other Variable Expenses) = $120
- Contribution Margin per Unit: $240 – $120 = $120
Step 2: Calculate Contribution Margin per Pound of Raw Material
Next, we determine how much contribution margin each product generates per pound of raw material. Given that the raw material costs $8 per pound, we can calculate the pounds of raw material used per unit for each product:
- Product A:
- Direct Materials Cost: $16
- Pounds of Raw Material per Unit: $16 ÷ $8 per pound = 2 pounds
- Contribution Margin per Pound: $62 ÷ 2 pounds = $31 per pound
- Product B:
- Direct Materials Cost: $64
- Pounds of Raw Material per Unit: $64 ÷ $8 per pound = 8 pounds
- Contribution Margin per Pound: $146 ÷ 8 pounds = $18.25 per pound
- Product C:
- Direct Materials Cost: $24
- Pounds of Raw Material per Unit: $24 ÷ $8 per pound = 3 pounds
- Contribution Margin per Pound: $120 ÷ 3 pounds = $40 per pound
Step 3: Prioritize Products Based on Contribution Margin per Pound
With 5,700 pounds of raw material available, Barlow Company should prioritize the products that offer the highest contribution margin per pound of raw material to maximize profitability.
- Product A: $31 per pound
- Product C: $40 per pound
- Product B: $18.25 per pound
Therefore, Barlow Company should focus on producing Product C first, followed by Product A, and lastly Product B.
Step 4: Allocate Raw Material
Given the limited raw material, the company should allocate it to maximize the total contribution margin:
- Product C:
- Contribution Margin per Pound: $40
- Available Raw Material: 5,700 pounds
- Maximum Units: 5,700 pounds ÷ 3 pounds per unit = 1,900 units
- Total Contribution Margin: 1,900 units × $120 per unit = $228,000
- Product A:
- Contribution Margin per Pound: $31
- Remaining Raw Material: 5,700 pounds – (1,900 units × 3 pounds per unit) = 0 pounds
- Therefore, no raw material remains for Product A.
- Product B:
- Contribution Margin per Pound: $18.25
- Remaining Raw Material: 0 pounds
- Therefore, no raw material remains for Product B.
Conclusion
By focusing on Product C, Barlow Company can utilize all available raw material and achieve a total contribution margin of $228,000. This approach ensures the most efficient use of limited resources to maximize profitability.