Question

Problem 12-24 Shutting Down or Continuing to Operate a Plant [LO12-2]

Birch Company normally produces and sells 47,000 units of RG-6 each month. The selling price is $30 per unit, variable costs are $10 per unit, fixed manufacturing overhead costs total $150,000 per month, and fixed selling costs total $40,000 per month.

Employment-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 12,000 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 $48,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $16,000. Because Birch Company uses Lean Production methods, no inventories are on hand.

Required:

1. What is the financial advantage (disadvantage) if Birch closes its own plant for two months?

2. Should Birch close the plant for two months?

3. At what level of unit sales for the two-month period would Birch Company be indifferent between closing the plant or keeping it open?

Answer 1

Solution 1:

Differential Analysis - Continue plant for 2 months (alt 1) or Shutdown plant for 2 months (Alt2)
Particulars	Continue plant for 2 months (Alt 1)	Shut down plant for 2 months (Alt 2)	Financial advantage (Disadvantage) of shutdown (Alternative 2)
Revenue	$720,000.00	$0.00	-$720,000.00
Costs:
Variable cost	$240,000.00	$0.00	-$240,000.00
Fixed manufacturing overhead cost	$300,000.00	$204,000.00	-$96,000.00
Fixed selling cost	$80,000.00	$72,000.00	-$8,000.00
Startup cost at the end of shutdown period	$0.00	$16,000.00	$16,000.00
Income / (Loss)	$100,000.00	-$292,000.00	-$392,000.00

Solution 2:

As there is net financial disadvantage of $392,000, therefore Birch should not close the plant for 2 months.

Solution 3:

Let at X unit sales for two months, birch company will be indifferent between closing the plant or keeping it open.

Therefore at X units, operating income will remain same in both alternatives

($30 X - $10X) - ($300,000 + $80,000) = -$292,000

20X = $88,000
X = 4400 units

Hence at 4400 units sales Birch company will be indifferent between closing the plant or keeping it open.