Question

Problem 11-18 Relevant Cost Analysis in a Variety of Situations [LO11-2, LO11-3, LO11-4]

Andretti Company has a single product called a Dak. The company normally produces and sells 60,000 Daks each year at a selling price of $32 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	10.00
Direct labor		4.50
Variable manufacturing overhead		2.30
Fixed manufacturing overhead		5.00	($300,000 total)
Variable selling expenses		1.20
Fixed selling expenses		3.50	($210,000 total)
Total cost per unit	$	26.50

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 90,000 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 25% above the present 60,000 units each year if it were willing to increase the fixed selling expenses by $80,000. What is the financial advantage (disadvantage) of investing an additional $80,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 90,000 Daks each year. A customer in a foreign market wants to purchase 20,000 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $1.70 per unit and an additional $9,000 for permits and licenses. The only selling costs that would be associated with the order would be $3.20 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 1,000 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 30% 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 60% 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 60,000 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 75%. 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

		Normal Capacity	60,000.00	Daks
			Per Dak
		Selling Price	$                   32.00
		Less: Direct Material	$                   10.00
		Less: Direct Labour	$                      4.50
		Less: Variable Manufacturing Overhead	$                      2.30
		Less: Variable Selling Expense	$                      1.20
		Contribution	$                   14.00
	I.a	Option: Increase in Fixed Selling Expense of $80000
		Increase in Sales units (25% of 60000)	15,000.00
		Contribution for Increase in Sales ( Increase in Sales * Contribution per Dak)	$         210,000.00
		Less: Additional Fixed Selling Expense	$           80,000.00
		Financial Advantage (Increase in Contribution less Increase in Fixed Selling Expense	$         130,000.00
	I.b	Yes, the option is viable.
	2
		Additional Variable Cost: Import Duty	$                      1.70
		Additional Fixed Cost	$             9,000.00
		Variable Selling Expense	$                      3.20
		Break Even Price = (Fixed Cost/Units)+Variable Cost per unit
		Revised Variable Cost for the offer:
		Direct Material	$                   10.00
		Direct Labour	$                      4.50
		Variable Manufacturing Overhead	$                      2.30
		Additional Variable Manufacturing Overhead	$                      1.70
		Variable Selling Overhead	$                      3.20
		Total Variable Cost	$                   21.70
		Break Even Price( ($9000/20000)+$21.7)	$                   22.15
	3	Minimum Price is its Variable Cost.
		Total Variable Cost:
		Direct Material	$                   10.00
		Direct Labour	$                      4.50
		Variable Manufacturing Overhead	$                      2.30
		Variable Selling Expense	$                      1.20
		Total	$                   18.00
	4	Normal Capacity for 2 months	10,000	Daks
		30% of Normal Capacity	3,000
		On Closure:
		Fixed Manufacturing Overhead (60% of Normal level)(($300000/12*2)*.6)	$           30,000.00
		Fixed Selling Overhead (80% of Normal level)(($210000/12*2)*.8)	$           28,000.00
	a.	Contribution Forgone (30% of Normal Capacity * Contribution per unit)	$           42,000.00
	b.	Fixed Cost Avoided (Total Fixed Cost for 2 months less Fixed Cost incurred inspite of Closure as calculated above)
		Fixed Manufacturing Overhead ($50000-30000)	$           20,000.00
		Fixed Selling Overhead ($35000-$28000)	$             7,000.00
		Total Fixed Cost Avoided	$           27,000.00
	c	Financial Advantage(Disadvantage) for Plant Closure is Fixed Cost Avoided less Contribution Forgone ($27000-$42000)	$         -15,000.00
		Hence, there is Financial Disadvantage in plant closure
	d.	No, it should not close the plant. Instead it should keep on producing at 30% of Normal Capacity
	5	Revised Fixed Manufacturing Overhead	25% of $300000	$ 75,000.00
		Revised Variable Selling Price	2/3 of $1.2	$            0.80
		Cost per unit Avoided:
		Direct Material	$                   10.00
		Direct Labour	$                      4.50
		Variable Manufacturing Overhead	$                      2.30
		Variable Selling Expense	$                      0.40
		Fixed Manufacturing Overhead per unit ($300000-75000)/60000	$                      3.75
		Fixed Selling Expense	$                      3.50
		Total Avoidable Cost per Unit	$                   24.45