Question

Birch Company normally produces and sells 43,000 units of RG-6 each month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is $25 per unit, variable costs are $16 per unit, fixed manufacturing overhead costs total $185,000 per month, and fixed selling costs total $48,000 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 11,000 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 $40,000 per month and its fixed selling costs by 11%. Start-up costs at the end of the shutdown period would total $13,000. Because Birch Company uses Lean Production methods, no inventories are on hand.

Required:

1a.	Assuming that the strikes continue for two months, what is the impact on income by closing the plant?

      

	Net income is by in two months

1b.	Would you recommend that Birch Company close its own plant?
	No Yes

2.	At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant or keeping it open?

	Level of sales unit in two months

Answer 1

2
Level of sales where the company is indifferent between the two = Fixed cost (Avoidable) / Contribution per unit
Level of sales where the company is indifferent between the two = $ 77560 / $ 9 = 8618 units (Rounded off)
Fixed cost = Avoidable fixed manufacturing cost + Avoidable fixed selling cost - Startup cost after two months
Fixed cost   = 80000 + 10560 - 13000 = $77560
Contribution per unit (calculated above) = $ 9