Question

Andretti Company has a single product called a Dak. The company normally produces and sells 84,000 Daks each year at a selling price of $50 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	6.50
Direct labor		8.00
Variable manufacturing overhead		3.40
Fixed manufacturing overhead		8.00	($672,000 total)
Variable selling expenses		4.70
Fixed selling expenses		5.50	($462,000 total)
Total cost per unit	$	36.10

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 113,400 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 35% above the present 84,000 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?

2. Assume again that Andretti Company has sufficient capacity to produce 113,400 Daks each year. A customer in a foreign market wants to purchase 29,400 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $3.70 per unit and an additional $14,700 for permits and licenses. The only selling costs that would be associated with the order would be $2.00 per unit shipping cost. What is the break-even price per unit on this order?

3. 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?

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% during the two-month period.

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

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

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

d. Should Andretti close the plant for two months?

5. An outside manufacturer has offered to produce 84,000 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 30%. Because the outside manufacturer would pay for all shipping costs, the variable selling expenses would be only two-thirds of their present amount. What is Andretti’s avoidable cost per unit that it should compare to the price quoted by the outside manufacturer?

Answer 1

1-a. Contribution margin per unit = Selling price per unit - Variable expenses per unit = $ 50 - $ 22.60 = $ 27.40.

Incremental contribution margin = $ 27.40 x ( 84,000 x 35 %) = $ 805,560.

Financial advantage ( disadvantage ) of investing additional $ 150,000 in fixed selling expenses = $ 805,560 - $ 150,000 = $ 655,560.

1-b. Yes, the additional investment would be justified.

2.

Variable manufacturing costs per unit	$ 17.90
Import duties per unit	3.70
Permits and licences ( $ 14,700 / 29,400)	0.50
Shipping costs per unit	2.00
Break-even price per unit	$ 24.10

3. Only the costs that have not been already incurred on the defective units are relevant.

Therefore, the unit cost that is relevant for setting a minimum selling price is the variable selling expenses of $ 4.70.

4. a. Activity level if the plant operates at 25 % capacity for two months = (84,000 units / 6) x 25% = 3,500 units.

If the plant is closed for two months, the contribution margin foregone would be 3,500 x $ 27.40 =$ (95,900)

b. Total fixed cost that the company can avoid = $ 672,000 / 6 x 70 % + $ 462,000 / 6 x 20 % = $ 93,800.

c. The financial advantage (disadvantage) of closing the plant for two months = $ 93,800 - $ 95,900 = $ ( 2,100)

d. No, Andretti should not close the plant for two months.

5.

Total variable manufacturing costs per unit	$ 17.90
Fixed manufacturing cost saved per unit ( $ 672,000 x 30% ) / 84,000	2.40
Variable selling expenses saved per unit ( $ 4.70 / 3)	1.57
Avoidable cost per unit	$ 21.87

The price quoted by the outside manufacturer should be less than $ 21.87.