Question

Andretti Company has a single product called a Dak. The company normally produces and sells 88,000 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	$	9.50
Direct labor		11.00
Variable manufacturing overhead		3.30
Fixed manufacturing overhead		7.00	($616,000 total)
Variable selling expenses		3.70
Fixed selling expenses		4.00	($352,000 total)
Total cost per unit	$	38.50

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 118,800 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 35% above the present 88,000 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?

2a. The company has 600 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?

2b. 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.

3a. How much total contribution margin will Andretti forgo if it closes the plant for two months?

3b. How much total fixed cost will the company avoid if it closes the plant for two months?

3c. What is the financial advantage (disadvantage) of closing the plant for the two-month period?

3d. Should Andretti close the plant for two months?

Answer 1

Andretti Company
1-a Calculation Of incremental Income
Revenue :-
S.P p.u		58
Expenses :-
DM	9.5
DL	11
Var. Mfg. OH	3.3
Var. Selling and Adm. Exp.	3.7
Total expenses		27.5
Contribution margin p.u		30.5
Contribution Margin ( 30800 * 30.50 )		9,39,400
Less:- Fixed Selling expenses		1,50,000
Net incremental Income		7,89,400
yes, the increased fixed expenses would be justified.
2 a- Relevant Cost
DM	Sunk cost
DL	Sunk cost
Var. Mfg. OH	Sunk cost
Var. Selling and Adm. Exp.	3.7
Minimum selling price	3.7
2 b - Impact on profits				If the company operates at 25 % Level
Net operating loss at 25 %	49489			Units produced = 88000 * 2/12 = 14667 * 25 %= 3667 units
If compnay is closed down				The profit that can be earned on these units
Fixed manufacturing OH cost ( 102667 * 35 %)	35933			Contribution margin = 3667 * 30.5 = $ 111844
Fixed Selling cost ( 58667 * 80 %)	46934			Less:- Fixed manufacturing OH = 616000 * 2/12 = 102666
Total Loss incurred by closing down the plant	82867			Fixed selling expenses = 352000 * 2/12 = 58667
Net disadvantage of closing the plant	-33378			Net loss incurred = 49489
3a. - 111844
3b. - 102666 + 58667 - 82867 = $ 78466
3c.financial disadvatage - $ 33378
3d. - No.