Scarce resources:

1
Scarce resources

• Making production decisions when resources are
  tight.
• Choosing among products.
• Setting production schedules

2
Agenda

• Reichard Maschinen GmbH written analysis
• Contribution approach - recap
• A more in-depth look at scarce resource decisions
• Group work Information Technology, Inc.

3
Reichard Maschinen GmbH Written Analysis

• A 10 assignment. Maximum of five pages (not
  including exhibits).
• Be sure you have downloaded the instructions for
  the write-up.
• Cover memo - a page or two.
• Analysis computations and reasoning
• Cover page, but no slick or stiff covers
• Typed, double-spaced, 12-point font.

4
Reichard Maschinen Written Analysis

• Decisions
• 1. Whether or not to manufacture plastic rings.
• 2. Alternative schedules for launching plastic
  rings.
• 3. Strategic implications of ring decision and
  effect on demand in both short- and long-run.

5
Contribution approach recap

• Contribution margin vs.
• Product line contribution
• Division contribution
• Segment contribution, etc.
• Traceable fixed costs.
• Differential vs. Relevant Costs.
• Your textbooks approach
• No conceptual difference - same answers!

6
Scarce resources

• What are resources? What is a bottleneck?
• How do resources relate to capacity?
• How do scarce resources change profit
  maximization problems?
• What if there is more than one scarce resource?

7
Example 1

• Suppose that Ajax Company produces products A and
  B, with the following selling prices and variable
  costs.
• A B
• Sales price per unit 25 30
• Variable cost per unit 10 18
• CM per unit 15 12
• CM ratio 60 40
• Machine time is limited. Product A takes 2
  minutes.Product B takes 1 minute. Which should
  Ajax produce?

8
Example 2

• Duo Company Duo manufactures two products, Uno
  and Dos. Contribution margin data follow
• Uno Dos
• Unit selling price 13.00 31.00
• Less DM 7.00 5.00
• DL 1.00 6.00
• V O/H 1.25 7.50
• Variable SA .75
  .50
• Unit contribution margin 3.00
  12.00

9
Example 2

• Duo Companys production process uses highly
  skilled labor, which is in short supply. The
  same employees work on both products and earn the
  same wage rate.
• Which of Duo Companys products is more
  profitable? Explain.

10
Example 2

• Duo Company Assume that the direct-labor rate
  is 24 per hour, and 10,000 labor hours are
  available per year. In addition, the company has
  a short supply of machine time. Only 8,000 hours
  are available each year. Uno requires 1 machine
  hour per unit, and Dos requires 2 machine hours
  per unit.
• Which product should Duo manufacture?

11
Tyler Tool Company

• Tyler Tool Company manufactures electric
  carpentry tools. The production department has
  met all production requirements for the current
  month and has an opportunity to produce
  additional units of product with its excess
  capacity. Unit selling prices and unit costs for
  three different drill models are as follows
• Home Deluxe Pro
• Selling price 58 65 80
• DM 16 20 19
• DL (10 / hr.) 10 15 20
• Variable overhead 8 12
  16
• Fixed overhead 16 5 15

12
Tyler Tool Company

• Variable overhead is applied on the basis of DL,
  while fixed overhead is applied on the basis of
  machine hours. There is sufficient demand for
  the additional production of any model in the
  product line.
• 1. If there are no constraints, which product
  should be produced?
• 2. If labor is scarce, which product should be
  produced?

13
University Hospital

• University Hospital has an outpatient surgery
  center that treats patients in three activity
  centers (1) Surgery, (2) Phase I recovery, and
  (3) Phase II recovery. At the end of Phase II
  surgery, patients go home. Daily capacities and
  production levels are as follows
• Surgery Phase I Phase II
• Daily capacity 40 30 60
• Daily production 30 30 30
• The hospital receives an average of 1,000 per
  surgery. The variable cost per surgery is 300.
  Demand is sufficient for 60. Surgeries not
  performed in the center go to regular surgery
  where variable costs are 700. Revenue is still
  1,000.

14
University Hospital

• Here are some alternatives that management is
  considering
• a. Continue performing 30 surgeries per day in
  the outpatient center and send 30 patients to
  regular surgery.
• b. Rebuild the recovery rooms so that some of
  the Phase II space could be used for Phase I
  recovery. This would cost 2,000 per day and
  would enable the outpatient center to perform 40
  surgeries per day and send 20 to regular surgery.
• c. Expand the facilities of the outpatient
  center at a differential cost of 15,000 per day
  so it could perform 60 surgeries per day, and
  service all of them in Phase I and II recovery.

15
University Hospital

• Approach Compute contribution from each
  alternative and compare.
• Continue performing 30 surgeries per day in the
  outpatient center and send 30 patients to regular
  surgery.

16
University Hospital

• Rebuild the recovery rooms so that some of the
  Phase II space could be used for Phase I
  recovery. This would cost 2,000 per day and
  would enable the outpatient center to perform 40
  surgeries per day and send 20 to regular surgery.

17
University Hospital

• Expand the facilities of the outpatient center at
  a differential cost of 15,000 per day so it
  could perform 60 surgeries per day, and service
  all of them in Phase I and II recovery.

18
Kickapoo Company
The Motor Division of Kickapoo Company can
increase its regular production of 900 units per
week by 100 units per week by adding a second
shift (400 man hours per day) - no more labor is
available. However, the labor cost per unit will
increase by one half. Other normal costs and
revenues are as follows
Price per unit 2500
Direct material (1000)
Direct labor (20 man hrs.) (500)
(750)
Variable overhead (200)
Fixed overhead (600)
Gross margin per unit 200
Allocated based on 1,200 units per week.
19
Kickapoo Company
1. What is the contribution margin on a unit
manu-factured during a regular shift?
2. What is the contribution margin on a unit
manu- factured during the second shift? Whats
gross margin?
20
Kickapoo Company Motor Division Profit
What is the total contribution of the additional
100 units per week? What is the contribution per
year?
What is the gross margin of the additional
100units per week? What is total gross margin
per week?
21
Kickapoo Company Company Profits
What is Kickapoos annual reported gross margin
fromMotors product at normal production?
22
Kickapoo Company Company Profit
What is Kickapoos annual income from Motors
productwith the 100 unit per week increase?
23
Kickapoo Company
Suppose Motor Division must choose between
manu- facturing its regular product or an altered
version using its idle capacity. The cost and
revenue information associated with the new
product are as follows
Selling price 2800 Materials
(600) Direct labor (36 man hours)
(900) Variable overhead (200) Product
contribution 1100
(1350)
Which product should Motor Division manufacture?
24
Kickapoo Company
25
Group work Information Technology, Inc.
Answer questions (1) and (2) in your groups
andhand in your answers at the end of the hour.
The best answer to part (2) requires a little
creativethinking.