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Problem B-5 (30 minutes)
1. The constraint is customer representatives’ time and the incremental profit is revenues less cost of
drugs sold and customer service costs.
Willows
Pharmacy
Swedish
Hospital
Pharmacy
Georgetown
Clinic
Pharmacy
Kristen
Pharmacy
Total revenues ............................
$344,880
$1,995,200
$1,414,170
$154,800
Cost of drugs sold .......................
263,340
1,446,520
1,047,660
120,960
Customer service costs ...............
12,240
62,640
39,900
4,500
Incremental profit (a) .................
$ 69,300
$ 486,040
$ 326,610
$ 29,340
Customer representative time (b)
180 hours
1,160 hours
570 hours
90 hours
Profitability index (a) ÷ (b)..........
$385 per hour
$419 per hour
$573 per hour
$326 per hour
The Georgetown Clinic Pharmacy is the most profitable of the customers, followed by the Swedish
Hospital Pharmacy, the Willows Pharmacy, and lastly Kristen Pharmacy.
2. The company could certainly afford to pay its customer representatives more in order to attract and
retain them. The company makes at least $326 in incremental profit per hour of customer
representative time after taking into account their current wages and commissions. Another way of
Problem B-7 (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
be used in the numerator when measuring profitability because it does
not represent the incremental profit from the segment. The incremental
profit from a segment is its revenue less its
avoidable
costs. Fully
Including nonavoidable costs in the numerator of the profitability
measure distorts the measure and may result in incorrect rankings of
the segments.
2. It is appropriate to use the segment revenue in the denominator of the
measuring the relative profitability of segments.
When would total revenue be the organization’s constraint? In truth,
it is difficult to imagine situations in which total revenue would be the
constraint. One possibility is that the organization’s customers have a
fixed total budget for spending on the organization’s products and
