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 $190,000 per month, and fixed selling costs total $44,000 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 9,000 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 $47,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $14,000. 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 Disadvantage to Birch by closing down plant is $91200(see working note1, 2 and 3)

2. No Birch should not close its plant but continue its operation during the two month period.

3.Birch would be indifferent between closing down and keeping it open if the sales units for the two month period would be 8880 units(i.e 4440 units/month)(see working note 4)

Working Notes:

1)Contribution per unit= Selling Price/unit-Variable Cost/unit= $20-$10=$10/unit

2 )Loss on operation during strike period:

Sales(9000units*2months*$20 )$3,60,000

Less: Variable Costs(9000 units*2mths*$10/)            $1,80,000

Total Contribution $1,80,000

Less: Fixed Manufacturing overhead($190000*2) ($3,80,000)

Less: Fixed Selling Costs($44000*2) ($88000)

Net Income/( LOSS) ( $ 2,88,000)

3 )Loss on shut down :

Unavoidable Fixed Manufacturing overheads($143000*2)=($2,86,000)

Unavoidable Fixed Selling Costs($39,600*2)= ($79200)

Additional Start up cost= ( $ 14,000)

Total Loss due to shut down= ($ 3,79,200)   

4 )Point of indifference for Birch Company= Shut down point

={Savings in fixed cost on shut down-(Start up costs)}/Contribution per unit

=($102800-$14000)/$10 per unit=8880 units i.e 4440 units per month.