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Problem B-5 (continued)
5. The selling price for the new product should at least cover its variable
cost and opportunity cost:
Selling price of Variable cost of
+
the new product the new product
Opportunity cost Amount of the constrained
per unit of the × resource required by a unit
constrained resource of the new product
Se
( )
lling price of $820 + $59 per hour × 10 hours
the new product
= $820 + $590 = $1,410
6. Salespersons who are paid a commission of 5% of gross revenues will
naturally prefer to sell a customer a pallet of anything other than cinder
blocks because they have the lowest gross revenues. However, given
the company’s constraint, they are in fact the company’s most profitable
Problem B-6 (45 minutes)
1. The relative profitability of segments should be measured by the
profitability index as follows:
Incremental profit from the segment
Profitability index= Amount of the constrained resource
used by the segment
2. It is appropriate to use the segment revenue in the denominator of the
profitability measure
only if total revenue is the organization’s
constraint
. In that case, the revenue of the segment would be the
Problem B-6 (continued)
Other situations might arise in which total revenue is the
Problem B-7 (60 minutes)
1. This problem can be solved by first computing the profitability index of
each customer and then ranking the customers based on that
profitability index:
Customer
Incremental
Profit
(A)
Regina’s
Time
Required
(B)
Profitability
Index
(A) ÷ (B)
Afonso ......
$195
5
$39
Carloni ......
$259
7
$37
Cullins ......
$105
3
$35
Frese ........
$170
5
$34
Gerst ........
$117
3
$39
Jelovich ....
$124
4
$31
Klarr .........
$192
6
$32
Melby .......
$144
4
$36
Rideau ......
$150
5
$30
Towner .....
$256
8
$32
Customer
Profitability
Index
Regina’s
Time
Required
Cumulative
Amount of
Regina’s Time
Required
Afonso ......
$39
5
5
Gerst ........
$39
3
8
Carloni ......
$37
7
15
Melby .......
$36
4
19
Cullins ......
$35
3
22
Frese ........
$34
5
27
Klarr .........
$32
6
33
Towner .....
$32
8
41
Jelovich ....
$31
4
45
Rideau ......
$30
5
50
Problem B-7 (continued)
2. The total profit on wedding cakes for the weekend after canceling the
four reservations would be:
Afonso ......
$195
Gerst ........
117
Carloni ......
259
Melby........
144
Cullins .......
105
Frese ........
170
Total .........
$990
3. To avoid disappointing customers, reservations should probably not be
accepted for any particular week after 27 hours of Regina’s time have
been committed for that week’s cakes. To ensure that only the most
profitable cake reservations are accepted, a reservation for any cake
Problem B-7 (continued)
4. Ms. Therau should consider changing the way prices are set so that they
include a charge for Regina’s time. On average, the prices may be the
same, but they should be based not only on the size of the cakes, but
5. Making Regina happy involves not asking her to work more than 27
hours per week decorating cakes. Making customers happy involves not
canceling their reservations, not raising prices, and providing top quality
wedding cakes. Ms. Therau can accomplish both of these objectives
and
Case B-8 (45 minutes)
Vectra’s management is not contemplating adding or dropping products; it
simply wants to redirect salespersons’ efforts toward the more profitable
products. Therefore, this is a volume trade-off decision and the appropriate
way to measure profitability is with the profitability index:
Unit contribution margin
Profitability index for =
a volume trade-off decision Amount of the constrained
resource used by one unit
The unit contribution margin is the selling price of a product less sales
commissions and the cost of sales, which is a variable cost in this company.
The operating expenses are all fixed.
Selling price
- Sales commission
- Cost of sales
Profitability index for =
a volume trade-off decision Amount of the constrained
resource used by one unit
The case states that management wants “to redirect the effort of
salespersons towards the more profitable products.” Therefore, the
constraint must be the effort of salespersons. Unfortunately, there is no
direct measure of the amount of salespersons’ effort required to sell a unit
of each product. However, all other things equal, if one product has twice
the sales commission per unit as another, then we can expect salespersons
to exert twice as much effort selling the first product. Effort is likely to be
Case B-8 (continued)
Note that this profitability index takes into account the salespersons’
