Question

Andretti Company has a single product called a Dak. The company normally produces and sells 88,000 Daks each year at a selling price of $62 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	9.50
Direct labor		10.00
Variable manufacturing overhead		3.60
Fixed manufacturing overhead		8.00	($704,000 total)
Variable selling expenses		2.70
Fixed selling expenses		4.50	($396,000 total)
Total cost per unit	$	38.30

A number of questions relating to the production and sale of Daks follow. Each question is independent.

Required:

1-a. Assume that Andretti Company has sufficient capacity to produce 118,800 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 35% above the present 88,000 units each year if it were willing to increase the fixed selling expenses by $110,000. What is the financial advantage (disadvantage) of investing an additional $110,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 118,800 Daks each year. A customer in a foreign market wants to purchase 30,800 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $2.70 per unit and an additional $21,560 for permits and licenses. The only selling costs that would be associated with the order would be $2.00 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 800 Daks on hand that have some irregularities and are therefore considered to be "seconds." Due to the irregularities, it will be impossible to sell these units at the normal price through regular distribution channels. What is the unit cost figure that is relevant for setting a minimum selling price?

4. Due to a strike in its supplier’s plant, Andretti Company is unable to purchase more material for the production of Daks. The strike is expected to last for two months. Andretti Company has enough material on hand to operate at 25% of normal levels for the two-month period. As an alternative, Andretti could close its plant down entirely for the two months. If the plant were closed, fixed manufacturing overhead costs would continue at 30% of their normal level during the two-month period and the fixed selling expenses would be reduced by 20% during the two-month period.

a. How much total contribution margin will Andretti forgo if it closes the plant for two months?

b. How much total fixed cost will the company avoid if it closes the plant for two months?

c. What is the financial advantage (disadvantage) of closing the plant for the two-month period?

d. Should Andretti close the plant for two months?

5. An outside manufacturer has offered to produce 88,000 Daks and ship them directly to Andretti’s customers. If Andretti Company accepts this offer, the facilities that it uses to produce Daks would be idle; however, fixed manufacturing overhead costs would be reduced by 30%. Because the outside manufacturer would pay for all shipping costs, the variable selling expenses would be only two-thirds of their present amount. What is Andretti’s avoidable cost per unit that it should compare to the price quoted by the outside manufacturer?

Answer 1

1-a.--Increased sales units of 88000*35%= 30800 units
Selling price/unit		62
Less:Variable costs:
Direct materials	9.5
Direct labor	10
Variable manufacturing overhead	3.6
Variable selling expenses	2.7
Total variable costs		25.8
Contribution /unit(62-25.8)		36.2
Incremental total contribution(30800*36.2)		1114960
Incremental fixed selling expenses		110000
Incremental revenue		1004960
So
Financial advantage of investing an additional $110,000 in fixed selling expenses		1004960
1-b.YES.The additional investment is justified because of the above financial advantage.

2.. Foreign order for 30800 units
Costs/unit associated with the order
Direct materials	9.5
Direct labor	10
Variable manufacturing overhead	3.6
Import duties	2.7
Shipping costs	2
Total variable costs	27.8
Permits & licences/unit(21560/30800)	0.7
Break-even price/unit on this order	28.5
(No profit/no loss price)

3.Irregular 800 units:
Costs that are relevant for setting minimum selling price --are the incremental costs
ie.not to be sold below this price----
Direct materials	9.5
Direct labor	10
Variable manufacturing overhead	3.6
Variable selling expenses	2.7
Total cost per unit	25.8
So,minimum selling price should be	25.8

4…
The company normally produces and sells 88,000 Daks each year
So,production & sale(units) for 2 months will be
88000/12*2*25%=
3667
Contribution /unit(62-25.8)	36.2
(Refer in 1-a. above)
a.Total contribution margin foregone if it closes the plant for two months=
3667*36.2=
132745
b.Total fixed cost the company will avoid if it closes the plant for two months:
Fixed manufacturing costs
704000/12mths*2 mths.*(1-30%)=	82133
(70% can be avoided)
Fixed selling expenses
396000/12mths*2 mths.*20%=	13200
(20% can be avoided)
Total fixed costs that can be avoided	95333
c.Financial advantage (disadvantage) of closing the plant for the two-month period
a.Total contribution margin foregone if it closes the plant for two months=	132745
b.Total fixed costs that can be avoided	95333
so, financial disadvantage	-37412
d. Should Andretti close the plant for two months--- NO as it results in financial disadvantage of $ 37412

5..Avoidable costs if there is no in-house manufacture:		Avoidable costs
Direct materials	9.5	9.5
Direct labor	10	10
Variable manufacturing overhead	3.6	3.6
Fixed manufacturing overhead	8	2.4	(8%*30%)
Variable selling expenses	2.7	0.9	(2.7*1/3)
Fixed selling expenses(ships them directly to Andretti’s customers)	4.5	4.5
Total cost per unit	38.3	30.9
Total avoidable cost per unit that it should compare to the price quoted by the outside manufacturer= $ 30.9