Question

Birch Company normally produces and sells 47,000 units of RG-6 each month. The selling price is $20 per unit, variable costs are $10 per unit, fixed manufacturing overhead costs total $185,000 per month, and fixed selling costs total $34,000 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 10,000 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 $49,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $12,000. Because Birch Company uses Lean Production methods, no inventories are on hand.

Required:

1. What is the financial advantage (disadvantage) if Birch closes its own plant for two months?

2. Should Birch close the plant for two months?

3. At what level of unit sales for the two-month period would Birch Company be indifferent between closing the plant or keeping it open?

What is the financial advantage (disadvantage) if Birch closes its own plant for two months?

Should Birch close the plant for two months?

	Yesradio button unchecked1 of 2 Noradio button unchecked2 of 2

At what level of unit sales for the two-month period would Birch Company be indifferent between closing the plant or keeping it open?

	Unit sales required for Birch to be indifferent

Answer 1

1.

	Continue operations	Shut down
Revenue	(10,000 x 20 x 2months) = 400,000	0
Less: Variable cost	(10,000 x 10 x 2months) = 200,000	0
Contribution	200,000	0
Fixed mfg cost	(185,000 x 2) = 370,000	(136,000 x 2) = 272,000
Fixed selling cost	(34,000 x 2) = 68,000	(30,600 x 2) = 61,200
Start up cost	0	12,000
Profit/ (Loss)	(238,000)	(345,200)

2. Birch Company should continue its operations because the loss will be higher if it shut downs the plant for 2 months. Hence it will be advantageous to continue the operations.

3. Level of production at which the company is indifferent between closing the Plant or keeping it open:

(a) Avoidable Fixed Cost = Total Fixed Cost - Unavoidable Fixed Cost

= Total Fixed Cost - Minimum Fixed Cost - Shut down cost

= Total Fixed Manufacturing and selling Cost - Minimum Fixed manufacturing and selling Cost - Shut down cost

= ($185,000 + $34,000 ) * 2 months - [( $136,000 + $ 30,600) * 2 months] - $ 12000

= $ 438,000 - $ 333,200 - $ 12,000

= $ 92,800

(b) Contribution per unit ($) = Selling price per unit - Variable Cost per unit

= $ 20 - $ 10 = $10

(c) Shut Down Point (Units) = Avoidable Fixed Costs / Contribution Per Unit

= $92,800 / $10

= 9280 Units

Conclusion: At 9280 units of capacity level the company is indifferent between closing the plant or keeping it open.