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 $64 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		2.20
Fixed manufacturing overhead		8.00	($704,000 total)
Variable selling expenses		2.70
Fixed selling expenses		4.00	($352,000 total)
Total cost per unit	$	36.40

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 110,000 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 25% above the present 88,000 units each year if it were willing to increase the fixed selling expenses by $130,000. What is the financial advantage (disadvantage) of investing an additional $130,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 110,000 Daks each year. A customer in a foreign market wants to purchase 22,000 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $3.70 per unit and an additional $17,600 for permits and licenses. The only selling costs that would be associated with the order would be $1.70 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 400 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 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

Answer 1 a)

Net Operating Profit before increasing selling expenses:
All amounts are in $
Sales 5,632,000 ( 88,000 * 64)
(Variable Cost) (2,147,200) (88,000 * 24.4)
Contribution Margin 3,484,800
(Fixed Cost) (1,056,000)
Net Operating profit 2,428,800

Net Operating Profit after increasing selling expenses:

Sales 7,040,000 ( 110,000 * 64)
(Variable Cost) (2,147,200) (110,000 * 24.4)
Contribution Margin 4,892,800
(Fixed Cost) (1,186,000)
Net Operating profit 3,706,800

Thus, Net Operating profit would increase by $1,278,000 if selling expenses are increased by $130,000
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Ans 1 b) Yes, the additonal investment is justified as Operating Profit increases by $1,278,000

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Ans 2
New variable cost per unit after import duty is levied:

= $24.4 (existing cost) + Import duty per unit + Shipping Cost per unit
= $24.4 + $3.70+ $ 1.70
= $29.8

Breakeven is a point where Total Revenue=Total Cost

TR = TC
Qty * SP = Qty * Variable expense + increased fixed expense
22,000 * x = 22,000 * 29.8 + 17,600
22,000x = 6,73,200
x= 30.6

Thus, break even price for this order is $30.6.
Note: Other fixed expenses have not been included because break even point is specifically asked for this specific order only.
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Answer 3) The cost figure relevant for setting a minimum price is $2.70 per dak, which is the selling expense per unit.
The return should be greater than the selling cost at the least.

Why?
- As they have been already been produced, all variable production costs like direct labour and direct material are already sunk.
- Fixed costs will not change whether units are sold or not.
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Answer 4)
Scenario A -  Production is continued

Units produced in two months in a normal scenario = 88,000 * 2/12 = 14,667
Units produced in two months at 25% of normal level = 14,667 * 1/4 = 3667 units

Net Income
Sales 2,34,688    (3667 * 64)
(Variable Cost) (89474.8)    (3667 * 24.4)
Contribution Margin 1,45,213
(Fixed Cost) (1,76,000) for 2 months
Net Operating profit (30,787)

Scenario B - Plant is Shut down

Net Income
Contribution Margin (46,933)    (7,04,000 *2/12 * .40)
(fixed cost) (46,933)    (3,52,000 *2/12 * .80)
Net Operating profit (93,866)

4 a ) 46,933 - Fixed manufacturing overhead for two months at 40% (Calculation shown above)

b) 46,933 - Fixed selling expenses for two months at 80 % (Calculation Shown Above)

c) There is a financial disadvantage of shutting down the plant i.e $ 63,079

d) Thus, plant should continue to operate at 25% normal levels of production.
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