Product Pricing and Profit Analysis in Bottleneck Operations
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Atlas Steel Company produces three grades of steel: high, good, and regular grade. Each of these products (grades) has high demand in the market, and Atlas is able to sell as much as it can produce of all three. The furnace operation is a bottleneck in the process and is running at 100% of capacity. Atlas wants to improve steel operation profitability. The variable conversion cost is $6 per process hour. The fixed cost is$1,530,000. In addition, the cost analyst was able to determine the following information about the three products:
High-grade Good Grade Regular Grade
Budgeted units produced 6,000 6,000 6,000
Total process hours per unit 15 15 12
Furnace hours per unit 5 3 2
Unit selling price $375 $350 $320
Direct materials cost per unit $160 $140 $130
The furnace operation is part of the total process for each of these three products. Thus, for example, 5 of the 15 hours required to process High Grade steel are associated with the furnace.
Instructions:
Determine the unit contribution margin for each product.
Provide an analysis to determine the relative product profitabilities, assuming that the furnace is a bottleneck.
Assume that management wishes to improve profitability by increasing prices on selected products. At what price would High and Good grades need to be offered in order to produce the same relative profitability as Regular Grade Steel?
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