A.

BEST PRODUCT MIX -considering capacity constraints

Scarce Resource Utilization Decision
A simple scarce resource allocation decision involves the following steps:

1. Calculate the contribution margin per unit of the scarce resource from each product.
2. Rank the products in the order of decreasing contribution margin per unit of scarce
resource.
3. Estimate the number of units of each product which can be sold.
4. Allocate scarce resource first to the product with highest contribution margin per unit of
scarce resource, then to the product with next highest contribution margin per unit of
scarce resource.

A scarce resource decision can be better explained using an example.

A company has 4,000 machine hours of plant capacity per month which are to be allocated to
products A and B. The following per unit figures relate to the products:

Product A B
$30
Sale Price $240
0
Costs:
Direct Material 100 70
Direct Labor 65 50
Variable Overhead 20 40
Fixed Overhead 15 30
Variable Operating Expenses 40 20
$24
Total Costs $210
0
Net Income $60 $30
Machine Hours Required 1.5 1.00
Assuming that the company can sell all its output, determine how many machine hours shall be
allocated to each product.

Solution

Product A B
$30
Sale Price $240
0
− Variable Cost 225 180
CM Per Unit $75 $60
÷ Machine Hours
1.50 1.00
Required
CM Per Machine Hour $50 $60
Since the company can sell all its output, the best decision is to allocate all machine hours (i.e.
scarce resource) to product B.
 B. CONTINUE OPERATING OR SHUTDOWN TEMPORARILY

-LOWEST LOSS

C. MAKE OR BUY

The following example illustrates the numerical part of a simple make-or-buy decision.

Example
The estimated costs of producing 6,000 units of a component are:

Per
  Total
Unit

Direct Material $10 $60,000

Direct Labor 8 48,000

Applied Variable Factory Overhead 9 54,000

Applied Fixed Factory Overhead 12 72,000

$1.5 per direct labor dollar  

  $39 $234,000

The same component can be purchased from market at a price of $29 per unit. If the component
is purchased from market, 25% of the fixed factory overhead will be saved.

Should the component be purchased from the market?

Solution

  Per Unit Total

  Make Buy Make Buy
Purchase Price   $29   $174,000
Direct Material $10   $60,000  
Direct Labor 8   48,000  
Variable Overhead 9   54,000  
Relevant Fixed Overhead 3   18,000  
Total Relevant Costs $30 $29 $180,000 $174,000
Difference in Favor of
  $1   $6,000
Buying