Question

Birch Company normally produces and sells 43,000 units of RG-6 each month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is $30 per unit, variable costs are $19 per unit, fixed manufacturing overhead costs total $155,000 per month, and fixed selling costs total $46,000 per monthEmployment-contract strikes in the companies that purchase the bulk of the RG-6 units have caused Birch Company’s sales to temporarily drop to only 14,000 units per month. Birch Company estimates that the strikes will last for two months, after which time sales of RG-6 should return to normal. Due to the current low level of sales, Birch Company is thinking about closing down its own plant during the strike, which would reduce its fixed manufacturing overhead costs by $60,000 per month and its fixed selling costs by 8%. Start-up costs at the end of the shutdown period would total $15,000. Because Birch Company uses Lean Production methods, no inventories are on hand.1 Assuming that the strikes continue for two months, what is the impact on income by closing the plant?2. At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant or keeping it open?

Answer 1

Answer:

a)No, the company should not close the plant; it should continue to operate at the reduced level of 28,000 units, because it would lead to a $199320 greater loss over the two-month period than if the company continues to operate.  By closing  down,  the  needs  of  these  customers  will  not  be  met  and they would move to another supplier

b) 9880 units

Explanation:

Contribution margin = selling price - variable cost = $30 - $19 = $11

Contribution margin lost = 14000 units / month * 2 months = 28000 units

Contribution margin lost by the plant closing = 28000 units * $11 = $308000

Fixed manufacturing overhead cost * number of months = $60,000 per month × 2 months = $120,000

Fixed selling cost = fixed selling costs total * 8% = $46000 * 0.08 = $3680

Costs avoided by closing the plant for two months = $120000 + $3680 = $123680

Net disadvantage before start up cost = Contribution margin lost by the plant closing - Costs avoided by closing the plant for two months = $308000 - $123680 = $184320

Start up cost = $15000

Closing plant disadvantage = Net disadvantage before start up cost + Start up cos = $184320 + $15000 = $199320

No, the company should not close the plant; it should continue to operate at the reduced level of 28,000 units, because it would lead to a $199320 greater loss over the two-month period than if the company continues to operate.  By closing  down the 28000 units produced would be lost,  the  needs  of  these  customers  will  not  be  met  and they would move to another supplier

b) Costs avoided by closing the plant for two months = $123680

less Start up cost = $15000

Net avoidable cost = $123680 - $15000 = $108680

Net avoidable cost/ Contribution margin per unit = $108680 / $11 = 9880 units