Sharp Aerospace has a five-year contract to supply North Plane with four specifi

Question

Sharp Aerospace has a five-year contract to supply North Plane with four specific spare parts for its fleet of airplanes. The following table provides information on selling prices, costs, and the number of units of each part that the company needs to produce annually according to the contract with North Plane:

Fixed overhead costs amount to $820,000 and are allocated based on the number of units produced. The company has a maximum annual capacity of 6,000 machine hours.

Questions:

a) If Sharp Aerospace could manufacture only one of the four parts, which spare part should it produce, based on the contribution margin per limited resource? Explain why.

b) Polaris Airline wants to buy 200 units of part A10 at 110% of the price currently paid by North Plane. Assume that for any of the four parts, Sharp Aerospace has to supply North Plane with at least 90% of the units specified in the contract. Should Sharp Aerospace accept the order for 200 units of part A10?

c) A new technology is available that costs $2,500,000 and would increase Sharp Aerospace's annual capacity by 25%. Should the company purchase the new technology? Assume that the technology has an estimated life for four years and that Sharp Aerospace can sell, at the same prices paid by North Plane, all the units it can produce of any of the four parts. Show all your calculations.

A10 A20 A30 A40 Sales $1,500,000 $875,000 $450,000 $2,400,000 Variable costs $1,235,000 $425,000 $187,000 $1,875,000 Contribution margin $265,000 $450,000 $263,000 $525,000 Production in units 1,000 250 750 600 Machine hours/unit 2 4 1.5 3

Explanation / Answer

a.

Working:

b.

c.

The annual capacity will increase by 25%. This means the available macnhine hours will increase by 1,500 hours (25% of 6,000).

Since A20 has the highest contribution margin per machine hour, the additional capacity shall be used to manufacture A20.

Working:

The company should produce A20 , so that the company can earn the highest income from the operations. This is because , since the number of machine hours is the constraint, the company should manufacture the part which gives maximum contribution per machine hour. As the total fixed costs are the same for ay product this wil result in the highest income for the company.

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