Question

Andretti Company has a single product called a Dak. The company normally produces and sells 81,000 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 10.00 Variable manufacturing overhead 2.00 Fixed manufacturing overhead 7.00 ($567,000 total) Variable selling expenses 2.70 Fixed selling expenses 2.50 ($202,500 total) Total cost per unit $ 32.70 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 101,250 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 25% above the present 81,000 units each year if it were willing to increase the fixed selling expenses by $140,000. What is the financial advantage (disadvantage) of investing an additional $140,000 in fixed selling expenses? 1-b. Would the additional investment be justified? 2. Assume again that Andretti Company has sufficient capacity to produce 101,250 Daks each year. A customer in a foreign market wants to purchase 20,250 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $4.70 per unit and an additional $12,150 for permits and licenses. The only selling costs that would be associated with the order would be $2.50 per unit shipping cost. What is the break-even price per unit on this order? 3. The company has 800 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 30% 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 81,000 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

Solution 1a:

Differential Analysis - Existing sales (alt 1)or increased sales with additional selling expenses (Alt2) - Andretti Company
Particulars	Existing Sale (81000 Units) (Alt 1)		Increased sales with additonal selling expenses (Alt 2) (101250 units)		Differential effect on income (Alt 2)
	Details	Amount	Details	Amount
Revenue	81000*$58	$4,698,000.00	101250*$58	$5,872,500.00	$1,174,500.00
Costs:
Direct Material	81000*$8.50	$688,500.00	101250*$8.50	$860,625.00	$172,125.00
Direct Labor	81000*$10	$810,000.00	101250*$10	$1,012,500.00	$202,500.00
Variable manufacturing Overhead	81000*$2	$162,000.00	101250*$2	$202,500.00	$40,500.00
Variable Selling Expenses	81000*$2.70	$218,700.00	101250*$2.70	$273,375.00	$54,675.00
Fixed manufacturing overhead		$567,000.00		$567,000.00	$0.00
Fixed Selling expenses		$202,500.00		$342,500.00	$140,000.00
Income / (Loss)		$2,049,300.00		$2,614,000.00	$564,700.00

Financial advantage of investing $140,000 in additonal fixed selling expenses = $564,700.

Solution 1b:

As there is net financial advantage, therefore additional investment is justified.

Solution 2:

Breakeven price per unit = (Total variable cost + Additional fixed cost) / Nos of units to be sold in foreign market

= [20250 * ($8.50 + $10 + $2 + $2.50 + $4.70) + $12,150] / 20250

= $28.30 per unit

Solution 3:

The relevant unit cost is $2.70 (Variable selling expenses). All other variable costs are sunk,as the units have already been produced and cost already incurred. The fixed costs would not be relevant, as they will not be affected by the sale of leftover units

Solution 4:

Contribution margin per unit = $58 - $8.50 - $10 - $2 - $2.70 = $34.80

a. Total contribution margin will andretti forgo if it closes the plant for 2 months = Total sales for 2 months * contribution margin per unit

= (81000*2/12*25%) * $34.80 = $117,450

b. Total fixed costs company avoid if it closes the plant for 2 months = ($567,000 * 70%*2/12) + ($202,500 * 20%*2/12) = $72,900

c. Financial advantage (disdvantage) of closing the plant for 2 months period = $72,900 - $117,450 = ($44,550)

d. As there is net financial disadvantage on closing the plant, therefore Andretti should not close the plant for 2 months.

Solution 5:

Avoidable cost per unit = Direct material + direct labor + Variable manufacturing overhead + Avoidable variable selling expenses + (Avoidable fixed manufacturing overhead / Nos of units)

= $8.50 + $10 + $2 + ($2.70*2/3) + ($567,000*30%/81000) = $24.40 per unit