Problem 2 (30 Points) welding Beaters, Inc., sells a wide range of drums, bins, boxes, and other containers which are used in the chemical industry. One of the company's products is a heavy-duty corrosion-resistant metal drum, called the SVD drum used to store toxic wastes. Production is constrained by the capacity of an automated welding machine which is used to make precision welds. A total of 2,000 hours time is available annually on the machine. Because each drum requires 0.5 hours of welding machine time, annual production is limited to 5,000 drums. At present, the welding machine is used exclusively to make the SVD drums. The accounting department has provided the following financial data concerning the SVD drums: $149.00 SVD Drums Selling price per drum Cost per drum: Direct materials $52.10 Direct labor ($18 per hour) 3.60 Manufacturing overhead 4.50 Selling and administrative expense 29.80 Margin per drum 90.00 $ 59.00 Management believes 6,200 SVD drums could be sold each year if the company had sufficient manufacturing capacity. As an alternative to adding another welding machine, management has considered buying additional drums from an outside supplier. Hardcore Industries, Inc., a supplier of quality products, would be able to provide up to 4,200 SVD-type drums per year at a price of $138 per drum, which Beaters would resell to its customers at its normal selling price after appropriate relabeling Joe Biden, Beaters's production manager, has suggested that the company could make better use of the welding machine by manufacturing bike frames, which would require only 0.4 hours of welding machine time per frame and yet sell for far more than the drums. Joe believes that Beaters could sell up to 1,600 bike frames per year to bike manufacturers at a price of $229 each. The accounting department has provided the following data concerning the proposed new product: $229.00 Bike Frames Selling price per frame Cost per frame: Direct materials $99.40 Direct labor ($18 per hour) 28.80 Manufacturing overhead Selling and administrative expense 47.80 Margin per frame 36.00 212.00 $ 17.00 The bike frames could be produced with existing equipment and personnel. Manufacturing overhead is allocated to products on the basis of direct labor-hours. Most of the manufacturing overhead consists of fixed common costs such as rent on the factory building, but some of it is variable. The variable manufacturing overhead has been estimated at $1.35 per SVD drum and $1.90 per bike frame. The variable manufacturing overhead cost would not be incurred on drums acquired from the outside supplier. Selling and administrative expenses are allocated to products on the basis of revenues. Almost all of the selling and administrative expenses are fixed common costs, but it has been estimated that variable selling and administrative expenses amount to $0.75 per SVD drum whether made or purchased and would be $1.30 per bike frame. All of the company's employeesdirect and indirect-are paid for full 40-hour work weeks and the company has a policy of laying off workers only in major recessions. As soon as your analysis was shown to the top management team Beaters, several managers got into an argument concerning how direct labor costs should be treated when making this decision. One manager argued that direct labor is always treated as a variable cost in textbooks and in practice and has always been considered a variable cost at Beaters. After all, "direct" means you can directly trace the cost to products. "If direct labor is not a variable cost, what is?" Another manager argued just as strenuously that direct labor should be considered a fixed cost at Beaters. No one had been laid off in over a decade, and for all practical purposes, everyone at the plant is on a monthly salary. Everyone classified as direct labor works a regular 40-hour workweek and overtime has not been necessary since the company adopted Lean Production techniques. Whether the welding machine is used to make drums or frames, the total payroll would be exactly the same. There is enough slack, in the form of idle time, to accommodate any increase in total direct labor time that the bike frames would require. Required: 1. Would you be comfortable relying on the financial data provided by the accounting department for making decisions related to the SVD drums and bike frames? 2. Compute the contribution margin per unit. (assume direct labor is a fixed cost] SHOW YOUR WORK 3. Compute the contribution margin per welding hour. [assume direct labor is a fixed cost] SHOW YOUR WORK 4. Assuming direct labor is a fixed cost: a. Determine the number of SVD drums (if any) that should be purchased and the number of SVD drums and/or bike frames (if any) that should be manufactured. SHOW YOUR WORK b. What is the increase (decrease) in net operating income that would result from this plan over current operations? SHOW YOUR WORK 5. Compute the contribution margin per unit. (assume direct labor is a variable cost] SHOW YOUR WORK 6. Compute the contribution margin per welding hour. [assume direct labor is a variable cost] SHOW YOUR WORK