Question

Birch Company normally produces and sells 30,000 units of RG-6 each month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is $22 per unit, variable costs are $14 per unit, fixed manufacturing overhead costs total $150,000 per month, and fixed selling costs total $30,000 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 8,000 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 $45,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $8,000. Because Birch Company uses Lean Production methods, no inventories are on hand. Required: 1a. Assuming that the strikes continue for two months, what is the impact on income by closing the plant? 1b. Would you recommend that Birch Company close its own plant? Yes No 2. At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant or keeping it open? (Hint: This is a type of break-even analysis, except that the fixed cost portion of your break-even computation should include only those fixed costs that are relevant [i.e., avoidable] over the two-month period.) Birch Company normally produces and sells 30,000 units of RG-6 each month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is $22 per unit, variable costs are $14 per unit, fixed manufacturing overhead costs total $150,000 per month, and fixed selling costs total $30,000 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 8,000 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 $45,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $8,000. Because Birch Company uses Lean Production methods, no inventories are on hand. Required: 1a. Assuming that the strikes continue for two months, what is the impact on income by closing the plant? 1b. Would you recommend that Birch Company close its own plant? Yes No 2. At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant or keeping it open? (Hint: This is a type of break-even analysis, except that the fixed cost portion of your break-even computation should include only those fixed costs that are relevant [i.e., avoidable] over the two-month period.) Birch Company normally produces and sells 30,000 units of RG-6 each month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is $22 per unit, variable costs are $14 per unit, fixed manufacturing overhead costs total $150,000 per month, and fixed selling costs total $30,000 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 8,000 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 $45,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $8,000. Because Birch Company uses Lean Production methods, no inventories are on hand. Required: 1a. Assuming that the strikes continue for two months, what is the impact on income by closing the plant? 1b. Would you recommend that Birch Company close its own plant? Yes No 2. At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant or keeping it open? (Hint: This is a type of break-even analysis, except that the fixed cost portion of your break-even computation should include only those fixed costs that are relevant [i.e., avoidable] over the two-month period.)

Answer 1

Solution:-

1a & 1b:-

Product RG-6 yields a contribution margin of $8 per unit ($22 – $14 = $8). If the plant closes, this contribution margin will be lost on the 16,000 units (8,000 units per month × 2 months) that could have been sold during the two-month period. However, the company will be able to avoid certain fixed costs as a result of closing down. The analysis is:

Contribution margin lost by closing the plant for two months ($8 per unit × 16,000 units)		$(128,000)
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost $45,000 per month × 2 months = $90,000)	$90,000
Fixed selling costs ($30,000 per month × 10% × 2 months)	6,000	96,000
Net disadvantage of closing, before start-up costs		(32,000)
Add start-up costs		8,000
Disadvantage of closing the plant		$ (40,000)

No, the company should not close the plant; it should continue to operate at the reduced level of 8,000 units produced and sold each month. Closing will result in a $40,000 greater loss over the two-month period than if the company continues to operate. An additional factor is the potential loss of goodwill among the customers who need the 8,000 units of RG-6 each month. By closing down, the needs of these customers will not be met (no inventories are on hand), and their business may be permanently lost to another supplier.

2:-

Birch Company will be indifferent at a level of 11,000 total units sold over the two-month period. The computations are:

Cost avoided by closing the plant for two months (see above)	$96,000
Less start-up costs	8,000
Net avoidable costs	$88,000