Question

Andretti Company has a single product called a Dak. The company normally produces and sells 89,000 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		12.00
Variable manufacturing overhead		2.50
Fixed manufacturing overhead		7.00	($623,000 total)
Variable selling expenses		2.70
Fixed selling expenses		4.00	($356,000 total)
Total cost per unit	$	36.70

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 120,150 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 35% above the present 89,000 units each year if it were willing to increase the fixed selling expenses by $120,000. What is the financial advantage (disadvantage) of investing an additional $120,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 120,150 Daks each year. A customer in a foreign market wants to purchase 31,150 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $2.70 per unit and an additional $21,805 for permits and licenses. The only selling costs that would be associated with the order would be $1.30 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 900 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 35% 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 89,000 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 Calculation of contribution margin per unit:

Selling Price	$64
Direct Material	8.50
Direct Labour	12.00
Variable Manufacturing Overhead	2.50
Variable Selling Expenses	2.70
Contribution Margin per Unit	$38.3

Additional Contribution from Sale of 31,150 Daks = 31,150*38.3 = $1,193,045

Increase in Fixed Selling Expenses = $120,000

Financial advantage (disadvantage) = $1,073,045

1-b Since there is additional profit, the additional investment is justified

2. Calculation of Break-even Price

Direct Material	8.50
Direct Labour	12.00
Variable Manufacturing Overhead	2.50
Import Duties	2.70
Selling Cost	1.30
Unit Variable Cost	$27

Total Cost = $27*31,1,50 + $21,805 = $862,855

Brek-even Price = $862,855/31150 = $27.7

3. . Since the products are impossible to be sold through regular distribution channel, the relevant cost for setting a minimum selling price would be equal to the variable cost per unit i.e. 8.5+12+2.5+2.7 = $25.7

4. Operation at 25% of normal level i.e. at 25%*89,000*2/12 = 3,708.33 units

Income Statement will be as follows:

Total Contribution 3,708.33*38.3	$142,029
Fixed Manufacturing Overhead	103,833
Fixed Selling Overhead	59,333
Operating Income	(21,137)

If closed,

Fixed Manufacturing Overheads 35%*103,833	$36,342
Fixed Selling Expenses 59,333*80%	47,466
Total	$(83,808)

a.Contribution Margin lost = $142,029

b.Fixed Cost Avoided = (103,833-36,342) + (59,333-47,466)

=$79,358

c.Financial advantage (disadvantage) of closing the plant = (83,808) – (21,137)

=(62,671)

d.No, it should not close the plant because of financial disadvantage