Problem - Product pricing and profit analysis with bottleneck operations

Palomar Chemical Company produces three products: ethylene, butane, and ester. Each of these products has high demand in the market, and Palomar Chemical is able to sell as much as it can produce of all three. The reaction operation is a bottleneck in the process and is running at 100% of capacity. Palomar Chemical wants to improve chemical operation profitability. The variable conversion cost is $20 per process hour. The fixed cost is $550,000. In addition, the cost analyst was able to determine the following information about the three products:

Ethylene Butane Ester

Budgeted units produced 15,000 15,000 15,000

Total process hours per unit 6 6 4

Reactor hours per unit 1.0 0.8 0.5

Unit selling price $400 $350 $250

Direct materials cost per unit $180 $130 $90

The reaction operation is part of the total process for each of these three products. Thus, for example, 1.0 of the 6 hours required to process ethylene are associated with the reactor.

Instructions -

1. Determine the unit contribution margin for each of the three products.

2. Provide an analysis to determine the relative product profitabilities, assuming that the reactor is a bottleneck.

3. Assume that management wishes to improve profitability by increasing prices on selected products. At what price would ethylene and butane need to be offered in order to produce the same relative profitability as ester?