Question

Andretti Company has a single product called a Dak. The company normally produces and sells 82,000 Daks each year at a selling price of $58 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	8.50
Direct labor		8.00
Variable manufacturing overhead		3.30
Fixed manufacturing overhead		9.00	($738,000 total)
Variable selling expenses		1.70
Fixed selling expenses		3.00	($246,000 total)
Total cost per unit	$	33.50

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 114,800 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 40% above the present 82,000 units each year if it were willing to increase the fixed selling expenses by $150,000. What is the financial advantage (disadvantage) of investing an additional $150,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 114,800 Daks each year. A customer in a foreign market wants to purchase 32,800 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $4.70 per unit and an additional $22,960 for permits and licenses. The only selling costs that would be associated with the order would be $1.80 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 82,000 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

Let us first work out the contribution per unit :

Selling price	58
Direct materials	8.5
Direct labor	8
Variable manufacturing overhead	3.3
Variable selling expenses	1.7
Contribution	36.5

The fixed overhead and fixed selling exepenses are sunk cost which does not vary with volume of product.

1-a. Assume that Andretti Company has sufficient capacity to produce 114,800 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 40% above the present 82,000 units each year if it were willing to increase the fixed selling expenses by $150,000. What is the financial advantage (disadvantage) of investing an additional $150,000 in fixed selling expenses?

Answer :

Increase in profit by 1,047,200 =(114800-82000)*36.5-150,000

1-b. Would the additional investment be justified? :

Answer :

Yes as it results into increase in profit by 1,047,200

2. Assume again that Andretti Company has sufficient capacity to produce 114,800 Daks each year. A customer in a foreign market wants to purchase 32,800 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $4.70 per unit and an additional $22,960 for permits and licenses. The only selling costs that would be associated with the order would be $1.80 per unit shipping cost. What is the break-even price per unit on this order?

Answer :

For this decision only variable cost needs to be considered so let us work out variable cost per unit

Variable Cost Per Unit :

Direct materials	8.50
Direct labor	8.00
Variable manufacturing overhead	3.30
Import Duties	4.70
Shipping Cost	1.80
Total Variable Cost per unit	26.30

Breakeven sale price per unit 27.0175 = (32,000*26.3+22,960)/32,000

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?

Answer :

The fixed cost per unit is going to be incurred whether units are produced or not. So variable cost incurred in production can be the the minimum target to recover & such variable cost will not incurr variable selling expenses as it will be only incurred for normal product :

Direct materials	8.50
Direct labor	8.00
Variable manufacturing overhead	3.30
Total	19.80

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?

82,000 is annual volume so we have to derive volume of 2 month with contribution per product

36.5*82,000/12*2=498,833

b. How much total fixed cost will the company avoid if it closes the plant for two months?

7,38,000*65%+246,000*20% =528,900

c. What is the financial advantage (disadvantage) of closing the plant for the two-month period?

The saving in fixed cost is advanatage while the loss is contribution for the 25% production.

528,900- 82,000*2/12*25%*36.5 = 404,191.67

d. Should Andretti close the plant for two months?

Close the plant.

5. An outside manufacturer has offered to produce 82,000 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 :

The avoidabale cost is reduction in fixed manufacturing ovehreahd which needs to be dervied per unit and then variable selling price per unit geeting reduced to 2/3 of present level

3.83 Per Unit =738,000*30%/82,000+1.7*2/3