Question

Andretti Company has a single product called a Dak. The company normally produces and sells 120,000 Daks each year at a selling price of $50 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	8.50
Direct labor		11.00
Variable manufacturing overhead		3.30
Fixed manufacturing overhead		5.00	($600,000 total)
Variable selling expenses		3.70
Fixed selling expenses		5.50	($660,000 total)
Total cost per unit	$	37.00

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 156,000 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 30% above the present 120,000 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 156,000 Daks each year. A customer in a foreign market wants to purchase 36,000 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $3.70 per unit and an additional $18,000 for permits and licenses. The only selling costs that would be associated with the order would be $2.10 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 40% 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 120,000 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

a)
Selling price per unit	$50.00
Less: Variable expenses per unit ($8.50 + $11.00 + $3.30 + $3.70)	$26.50
Contribution Margin	$23.50
Increased unit sales (120,000 units × 30%)	36000	Units
Contribution margin per unit	x $23.50
Incremental contribution margin	$846000.00
Less added fixed selling expense	$110000.00
Incremental net operating income (Financial Advantage of Investing )	$736000.00
b)
Yes, Additional investment in Fixed Assets would be justified.
2. Assume again that Andretti Company has sufficient capacity to produce 156,000 Daks each year. A customer in a foreign market wants to purchase 36,000 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $3.70 per unit and an additional $18,000 for permits and licenses. The only selling costs that would be associated with the order would be $2.10 per unit shipping cost. What is the break-even price per unit on this order?
Variable manufacturing cost per unit = $8.50 + $11 + $3.30	$22.80
Import duties per unit	$3.70
Permits and licenses ($18000 ÷ 36000 units)	$0.60
Shipping cost per unit	$2.10
Break-even price per unit	$29.20
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?
The relevant cost is $3.70 per unit, which is the variable selling expense per Dak.
The variable production costs are sunk and fixed selling expenses are not relevant because they will be incurred whether or not the irregular units are sold
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 40% of their normal level during the two-month period and the fixed selling expenses would be reduced by 20%. What would be the impact on profits of closing the plant for the two-month period? (Enter losses/reductions with a minus sign. Round intermediate calculations to 2 decimal places. Round number of units calculation and final answers to nearest whole number.)
	Continue to Operate	Close the Plant
Sales (5000 units x $50)	$250000.00	$0.00
Less: Variable expenses (5000 units × $26.50 per unit	$132500.00	$0.00
Contribution Margin	$117500.00	$0.00
Contribution margin lost if the plant is closed	-$117500.00	(a)
Fixed expenses:
Fixed manufacturing overhead cost
$600,000 × 2/12	$100000.00
$600,000 × 2/12 x 40%		$40000.00
Fixed selling expense
$660,000 × 2/12	$110000.00
$660,000 × 2/12 x(1- 20%)		$88000.00
Total Fixed Costs	$210000.00	$128000.00
Fixed costs that can be avoided if the plant is closed	$82000.00	(b)
Net operating income (loss)	-$92500.00	-$128000.00
Net disadvantage of closing the plant -$107208.33 - (-$67783.33 )	-$35500.00
(d) The plant should not be closed
120,000 units per year × 2/12	20000	units
20000 units × 25% =	5000	Units Produced and Sold
5
5)An outside manufacturer has offered to produce 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. Compute the unit cost that is relevant for comparison to the price quoted by the outside manufacturer. (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Variable manufacturing cost	$22.80
Fixed manufacturing overhead cost ($600,000 × 30% = $180,000; $180,000 ÷ 120,000 units	1.5
Variable selling expense ($3.70 × 1/3)	$1.23
Total costs avoided	$25.53
To be acceptable, the outside manufacturer’s quotation must be less than $25.53 per unit.