Question

Problem 10-18A Relevant Cost Analysis in a Variety of Situations [LO10-2, LO10-3, LO10-4]

Andretti Company has a single product called a Dak. The company normally produces and sells 87,000 Daks each year at a selling price of $44 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	8.50
Direct labor		12.00
Variable manufacturing overhead		3.40
Fixed manufacturing overhead		9.00	($783,000 total)
Variable selling expenses		4.70
Fixed selling expenses		3.50	($304,500 total)
Total cost per unit	$	41.10

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 117,450 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its sales by 35% above the present 87,000 units each year if it were willing to increase the fixed selling expenses by $110,000. Calculate the incremental net operating income. (Round all dollar amounts to 2 decimal places.)

          

1-b.	Would the increased fixed selling expenses be justified?
	Yes No

2.

Assume again that Andretti Company has sufficient capacity to produce 117,450 Daks each year. A customer in a foreign market wants to purchase 30,450 Daks. Import duties on the Daks would be $2.70 per unit, and costs for permits and licenses would be $15,225. The only selling costs that would be associated with the order would be $2.40 per unit shipping cost. Compute the per unit break-even price on this order. (Round your answers to 2 decimal places.)

          

3.	The company has 400 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 unit cost figure is relevant for setting a minimum selling price? (Round your answer to 2 decimal places.)

         

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%. What would be the impact on profits of closing the plant for the two-month period? (Enter losses/reductions with a minus sign. Round intermediate calculations to 2 decimal places. Round number of units calculation and final answers to nearest whole number.)

            

5.

An outside manufacturer has offered to produce 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 75%. Because the outside manufacturer would pay for all shipping costs, the variable selling expenses would be only two-thirds of their present amount. Compute the unit cost that is relevant for comparison to the price quoted by the outside manufacturer. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

1-a Calculation of contribution margin per unit:

Selling Price	$44
Direct Material	8.50
Direct Labour	12.00
Variable Manufacturing Overhead	3.40
Variable Selling Expenses	4.70
Contribution Margin per Unit	$15.4

Additional Contribution from Sale of 30,450 Daks = 30,450*15.4 = $468,930

Increase in Fixed Selling Expenses = $110,000

Financial advantage (disadvantage) = $358,930

i.e. net advantage

1-b Since there is additional profit, the additional investment is justified.

YES

2. Calculation of Break-even Price

Direct Material	8.50
Direct Labour	12.00
Variable Manufacturing Overhead	3.40
Import Duties	2.70
Selling Cost	2.40
Unit Variable Cost	$29

Total Cost = $29*30,450 + $15,225 = $898,275

Break-even Price = $898,275/30,450= $29.5

3. . Since the products are impossible to be sold through regular distribution channel, the relevant cost for setting a minimum selling price would be equal to the variable cost per unit i.e. 8.5+12+3.4+4.7 = $28.6

4. Operation at 25% of normal level i.e. at 25%*87,000*2/12 = 3,625 units

Income Statement will be as follows:

Total Contribution 3,625*15.4	$55,825
Fixed Manufacturing Overhead 783,000*2/12	130,500
Fixed Selling Overhead 304,500*2/12	50,750
Operating Income	$(125,425)

If closed,

Fixed Manufacturing Overheads 30%*783,000*2/12	39,150
Fixed Selling Expenses 304,500*80%*2/12	40,600
Total	$(79,750)

Impact on profits on closing = (79,750) – (125,425) = $45,675

i.e. loss will be reduced by $45,675 i.e. profit