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

Statement showing calculation of financial advantage
Particulars	Amount ($)
Profit if business continues	100000
Less:
Saving if shuts down	72000
Net Financial Advantage	28000

Notes:

If Business continue
Particulars	Amount ($)
Selling Price per unit	30
Less: Varaible Cost	10
Contribution margin	20
Sales unit during strikes	12000
Total Contribution	240000
Less:
Fixed manufacturing Overhead cost	150000
Fixed Selling Cost	40000
Profit for one month	50000
Period of strike	2 months
Net Profit during strike period	100000
Saving if business temporarily shuts down
Particulars	Amount ($)
Saving in Fixed manufacturing cost	48000
Saving in Fixed selling cost	4000
(40000*10%)
Total Saving	52000
Less:
Start up costs	16000
Net saving	36000
Period of strike	2 months
Total saving	72000

For computing financial advantage we are require to find the difference between saving and income under both the alternatives. Than we can find out the advantage of one over the other by subracting the respective income

2. No, Birch company should not close the plant because it has financial advantage of $ 28000 when it continues to run. So it should continue the business.

3. Indifference point is the point where profit under both the alternatives is equal. i.e. Profit when business continue and saving when business shuts down should be equal.

Let the number of units at indifference point =X

Than, 20X-190000=36000

for solving for X= 11300 units.