The Denver Corporation manufactures filing cabinets in two operations: machining

Question

The Denver Corporation manufactures filing cabinets in two operations: machining and finishing. It provides the following information:

Machining Finishing

Annual capacity 120,000 units 100,000 units

Annual production 100,000 units 100,000 units

Fixed operating costs (excluding direct materials) $600,000 $300,000

Fixed operating costs per unit produced $6 per unit $3 per unit

($600,000/100,000; $300,000/100,000)

Each cabinet sells for

$ 75$75

and has direct material costs of

$ 35$35

incurred at the start of the machining operation.

DenverDenver

has no other variable costs.

DenverDenver

can sell whatever output it produces. The following requirements refer only to the preceding data. There is no connection between the requirements.Read the requirements

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Requirement 1.

Denver is considering using some modern jigs and tools in the finishing operation that would increase annual finishing output by 1,150units. The annual cost of these jigs and tools is $35,000. Should Denver acquire these tools? Show your calculations.

Producing 1,150 more units will generate less or more contribution (throughput) margin and operating income because

finishing is a bottleneck operation; machining is not or machining is a bottleneck operation; finishing is not

.Select the formula, then enter the amounts to calculate the change in throughput contribution.

Change in throughput

x

=

contribution

x

=

Should Denver acquire these tools?

Change in throughput

x

=

contribution

x

=

Explanation / Answer

Contribution margin is the differnce between sales and variable cost of the product sold. It is the portion of sales (left after covering variable cost) which can be used to cover fixed costs. It helps to determine the profitability of individual product line because higher the contribution margin higher will be the profits.

Given in problem that selling price of each cabinet is $75 while variable material cost is $35 per cabinet. Therefore, contribution margin will be as follows:

Contribution margin/ per unit = $40 ($75 - $35)

If Denver acquires the modern jigs and tools then output will increase by 1,150 units. The contribution margin/unit is $40 as calculated above. But the annual cost of these jigs and tools is $35,000. So, increase in operating income by acquiring new jigs and tools will be as follows:

Denver should acquire the new jigs and tools because it has increased the contribution margin ($46,000) which is higher than cost of acquiring the new tools ($35,000).

Increase in contribution margin ($40/unit * 1,150 units) = $46,000 Increase in cost of acquiring new jigs and tools =$35,000 Increase in operating income by investing in jigs and tools =$11,000

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