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.)

          

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

Andretti Company

1. Determination of the financial advantage or disadvantage of investing an additional $110,000 in fixed selling expenses:

Assumptions –

Increase in unit sales by 35% from 87,000 units to reach 117,450 units

Fixed manufacturing overheads remain same

Selling administrative overheads increase $110,000

Calculation of contribution margin –

Contribution margin = unit sales price – unit variable cost

Unit sales price =$44

Unit variable cost –

Direct materials$8.50

Direct labor$12.00

Variable manufacturing overhead $3.40

Variable selling overhead$4.70

Contribution margin = $44 - $28.60 = $15.40

Determination of additional net income from sale of additional units –

Additional units = 30,450 (87,000 x 35%)

Additional contribution = $15.40 x 30,450 = $468,930

Additional selling expenses$110,000

Additional income$358,930

Hence, the financial advantage of investing an additional $110,000 in fixed selling expenses to produce and sell additional 35% units (30,450) each year is increase in net income by $358,930.

1-b.Since the company has enough capacity to produce 117,450 Daks the increase in production and sales by 35% allows the company to fully absorb the fixed manufacturing overhead and selling and administration overhead.

Hence, the company is justified to make the additional investment of $110,000 to produce additional 35% units of Daks.

1. Evaluation of special order:

Given information –

            Number of units          30,450

Additional variable cost –

Import duty     $2.70

So, revised variable cost per unit –

Direct material            $8.50

Direct labor                 $12.00

VMOH                        $3.40

Selling OH                  $2.40

Import duty                 $2.70

Total variable cost per unit      $29

Additional fixed cost for permits and licenses $15,225

Break-even price per unit for the order,

At break-even, total revenues = total costs

Let the break-even price per unit be $x,

Revenues = $30,450 x

Total costs = ($29x 30,450) + $15,225

                        = $898,275

Hence, $30,450 x = $898,275

So, x = 898,275/30,450 = $29.50

The break-even price per unit for the special order is $29.50

1. Determination of the unit cost figure that is relevant for setting the minimum price for the 400 units to be sold as ‘seconds’:

The relevant unit cost is the variable selling price - $4.70

Since the 400 Daks are already produced, the variable production costs are sunk costs and no more relevant.

The fixed costs are also sunk costs.

Since the 400 Daks are not to be sold through regular channels, the relevant unit cost figure for the determination of the minimum selling price is the variable selling expenses - $4.70

Normal production level – 87,000 units

25% of production level – 21,750 units

If the company closes the plant entirely for two months, the company has to forego the entire contribution margin on the normal capacity.

The contribution foregone = $15.40 x 87,000 =$1,339,800

Since the company would incur 30% of fixed manufacturing cost, despite closing down of the plant,

The fixed cost, the company would avoid is 70% 70% of $783,000 =$548,100

The fixed selling and administrative costs is reduced by 20% = 20% of $304,500 =$60,900

Total fixed costs the company would avoid by closing the plant for two months = $548,100 + $60,900 = $609,000

c. financial advantage or disadvantage of closing the plant for two months –

Contribution foregone= ($1,339,800)

Fixed costs avoided= $609,000

Disadvantage of closing the plant = excess contribution lost over avoidable fixed cost

= ($730,800)

d. assuming the company operates the plant for two months -

Contribution from 25% production = $15.40 x 21,750 units =$334,950

Total fixed cost –

Fixed manufacturing overhead$783,000

Fixed selling overhead$304,500$1,087,500

Net loss $752,550

Comparison of the net loss from continuing production with the net disadvantage of closing the plant for two months, $730,800 – $752,550 = -$21,750

Since the relative loss on closing the plant is lower compared to production at 25%, (net loss on continuing production = $21,750), the recommendation is to close down the plant for two months.

5a Determination of Andretti’s avoidable cost per unit that it should compare to the price quoted by the outside manufacturer:

Number of units offered to produce 87,000

Avoidable variable costs –

Direct materials cost$8.50

Direct labor cost$12.00

Variable MOH$3.40

Variable S&A OH$1.57 ($4.70 x 1/3)

Total avoidable variable cost $25.47

Add: Avoidable fixed cost (75% of $783,000)/87,000 =$6.75

Total avoidable cost = $25.47 + 6.75 = $32.22

Avoidable cost per unit =$32.22

Hence, Andretti should accept a price that is less than $32.22 per Dak from an outside manufacturer.