Advanced Management Accounting

Week 4
Product Mix Decisions

Instructor: Zhihong Wang, PhD

Product-Mix Decisions with Capacity
Constraints
• Product-mix decisions with capacity constraints are
decisions that managers make about which products to
sell and in what quantities under certain capacity
constraints. These decisions usually have only a short-run
focus because they typically arise in the context of
capacity constraints that can be relaxed in the long run.
Product-Mix Decisions with Capacity
Constraints
• Decision rule (with a constraint):
¡ Choose the product that produces the highest
contribution margin per unit of the constraining resource
(not the highest contribution margin per unit of the
product).
In-class Exercise
• Capacity constraints include ________.

• A) increased demand of warranty services for a pharmaceutical product

• B) increased need of display space for a retailer
• C) decreased demand for a pharmaceutical product
• D) increased fuel efficiency of cars
Single Constraints
Example
UST manufactures two products: A and B. The following table shows the
selling prices, costs and CM of the two products. Only 80 machine hours
are available daily for assembling products. Which product should UST
choose to maximize operating income?

ITEM PRODUCT A PRODUCT B

Selling price $10 $30
Variable Cost per unit $6 $15
CM / unit $4 $15

Machine Hours / unit .5 3

CM / Machine Hour $8 $5
CM for 80 machine $640 $400
hours
In-class Exercise
Springer Products manufactures three different product lines, Model X, Model Y,
and Model Z. Considerable market demand exists for all models. The following
per unit data apply:

Model X Model Y Model Z

Selling price $52 $60 $74
Direct materials 8 8 8
Direct labor ($16 per hour) 16 16 32
Var. support costs ($5/machine-hour) 5 10 10
Fixed support costs 12 12 12

If there is excess capacity, which model is the most profitable to produce?

A) Model X
B) Model Y
C) Model Z
D) Both Model X and Model Y have same and highest profitability
In-class Exercise
Springer Products manufactures three different product lines, Model X, Model Y,
and Model Z. Considerable market demand exists for all models. The following
per unit data apply:

Model X Model Y Model Z

Selling price $52 $60 $74
Direct materials 8 8 8
Direct labor ($16 per hour) 16 16 32
Var. support costs ($5/machine-hour) 5 10 10
Fixed support costs 12 12 12

If the availability of total machine hours is constrained, which model is the most
profitable to produce?
A) Model X
B) Model Y
C) Model Z
D) Both Model X and Model Y have same and highest profitability
In-class Exercise
Multiple Constraints
Linear Programming
When there are multiple constraints, manages can use
Linear programming to determine the number of each type of
product to produce.
Linear programming (also called linear optimization) is a
method to achieve the best outcome (such as maximum
profit or lowest cost) in a mathematical model whose
requirements are represented by linear relationships.
Example
UST manufactures two products: A and B. Financials are shown below.
Only 80 machine hours and 10 testing hours are available daily for
assembling and testing products. Due to RM constraints, UST cannot
produce more than 10 B per day. Which product should UST choose to
maximize operating income?

ITEM PRODUCT A PRODUCT B

Selling price $10 $30

Variable Cost per unit $6 $15

CM / unit $4 $15

Machine Hours / unit .5 3

Testing hours / unit 1 0.5
Steps to Solve an LP problem
Step 1: Determine the Objective Function
Objective Function expresses the objective to be maximized
or minimized.
E.g., find the combination of product A and B that maximizes
total contribution margin
TCM = $4A + $15B
Steps to Solve an LP problem
Step 2: Specify the Constraints
A constraint is mathematical inequality or equality that must
be satisfied by the variables in a mathematical model.
E.g., Assembly constraint: 0.5A + 3B < 80
Testing constraint: 1A + 0.5B < 10
RM constraint for B: B ≤ 10
No negative production: A ≥ 0 and B ≥ 0
Steps to Solve an LP problem
Step 3: Compute the Optimal Solution
A constraint is mathematical inequality or equality that must
be satisfied by the variables in a mathematical model.
E.g., Assembly constraint: 0.5A + 3B < 80
Testing constraint: 1A + 0.5B < 10
RM constraint for B: B ≤ 20
No negative production: A ≥ 0 and B ≥ 0

Use Excel Solver Add-in to solve this problem

In-class Exercise (LP Part I)
In-class Exercise (LP Part II)