Question

McNulty, Inc., produces desks and chairs. A new CFO has just been hired and announces a new policy that if a product cannot earn a margin on sales of at least 20 percent, it will be dropped. The margin is computed as product gross profit divided by reported product cost.Manufacturing overhead for year 1 totaled $800,000. Overhead is allocated to products based on direct labor cost. Data for year 1 show the following: Chairs DesksSales revenue $ 1,150,000 $ 2,105,000 Direct materials 584,000 800,000 Direct labor 160,000 340,000 Required:a-1. Based on the CFO's new policy, calculate the profit margin for both chairs and desks.Profit Margin (%)Chairs Desks a-2. Which of the two products should be dropped?b. Regardless of your answer in requirement a, the CFO decides at the beginning of year 2 to drop the chair product. The company cost analyst estimates that overhead without the chair line will be $650,000. The revenue and costs for desks are expected to be the same as last year. What is the estimated margin for desks in year 2?

Answer 1

McNulty, Inc.

Chairs Desks

a) Profit margin (%) 6.33% 31.36%

b) The estimated margin for desks in year 2 is:

= 17.6%

Step-by-step explanation:

a) Data and Calculations:

Expected gross profit margin on cost = 20%

Manufacturing overhead for year 1 = $800,000

Chairs Desks Total

Sales revenue $ 1,150,000 $ 2,105,000 $ 3,255,000

Direct materials 584,000 800,000 1,384,000

Direct labor 160,000 340,000 500,000

Overhead 337,572 462,428 800,000

Total costs $1,081,572 $1,602,428 $2,684,000

Gross Profit $68,428 $502,572 $571,000

Profit margin 6.33% 31.36% 21.27%

Margin (%) = Gross profit/Total costs * 100

Allocation of Manufacturing Overhead based on direct labor cost:

Chairs = $337,572 ($584,000/$1,384,000 * $800,000)

Desks = $462,428 ($800,000/$1,384,000 * $800,000)

Year 2:

Desks

Sales revenue $ 2,105,000

Direct materials 800,000

Direct labor 340,000

Overhead 650,000

Total costs $ 1,790,000

Gross Profit $315,000

Profit margin 17.6%