Question

Birch Company normally produces and sells 45,000 units of RG-6 each month. The selling price is $20 per unit, variable costs are $10 per unit, fixed manufacturing overhead costs total $175,000 per month, and fixed selling costs total $32,000 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 $41,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $15,000. 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?

Answer 1

1. Financial advantage or disadvantage:

There is some UN avoidable fixed expenditure incurred whether or not plant shutdown.

Unavoidable fixed cost = ($175,000-$45,000) + ($32,000-10%)

= $130,000 + $28,800

= $158,800

Now, unavoidable fixed expenses for two months would be $158,800*2 is $317,600.

Add start up expenses of $15,000.

Therefore, total unavoidable fixed expenses = $317,600+$15,000

= $332,600

2.) Determine whether to shutdown:

Details	Amount
Selling price	$                  20
V cost	$                  10
Contribution	$                  10
Total contribution (11,000 units)	$       110,000
Less: Fixed costs
Fixed manufacturing overhead	$       175,000
Fixed selling expenses	$ 32,000
Net loss	($97,000)

Net loss for two months if plant not shut down is $194,000 (i.e., $97,000*2 months).

Now, the benefit of continuing with low sales without shutdown is $136,400 (i.e., $317,600-$194,000).

Therefore, as the loss of continuing without shutdown the plant is less than shut down the plant, it is recommended NOT to shut down the plant and continuing with low level of sales at only 11,000 units per month.

3.)Sales level where it is indifferent to continue or shutdown:

Indifference point = (Total fixed costs – Avoidable fixed costs) / Contribution per unit

= ($207,000^* - $44,200^**) / $10

= 15,320 units

*= $175,000+$32,000

** = $41,000+$3,200