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 $200,000 per month, and fixed selling costs total $50,000 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 12,000 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 $50,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $13,000. 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

Requirement 1:-

Calculate the profit under two alternatives mentioned in the question

Particulars	Keeping the plant (Per month)	Shutting the plant(Per month)
Net Income	240,000	-
Less:- Variable costs	(120,000)	-
Less:- Fixed manufacturing overheads	(200,000)	(150,000)
Less:- Fixed selling costs	(50,000)	(45,000)
Operating Income/Loss	(130,000)	(195,000)

Note for Shutting the plant option(All data calculated per month with exception to startup cost which is one time payment)

Fixed manufacturing overheads = $200,000 - $50,000 reduction = $150,000

Fixed selling costs = Reduction of 10% = $50,000 - $50,000(10%) = $50,000 - $5,000

Fixed selling costs = $45,000

Note for Operating the plant option

Revenue = $20 * 12,000 units = $240,000

Variable costs = $10 * 12,000 units = $120,000

The Financial disadvantage of if the company closes the plant = $195,000 - $130,000 = $65,000 per month + Startup costs of $13,000

Hence, the financial disadvantage = $65,000 * 2 + $13,000

Financial disadvantage = $130,000 + $13,000

Financial Disadvantage = $143,000

Financial Disadvantage for 2 months = $143,000

Requirement 2:-

Birch should not close the plant because it is facing a financial disadvantage of $143,000 if it closes the plant for 2 months.

Requirement 3:-

Level of unit sales where Birch will be indifferent to closing the plant and keeping it open is

Let the number of units per month be X

X($20 - $10) - Fixed manufacturing costs - Fixed selling costs = ($195,000 per month * 2 months) + ($13,000)

10X - ($200,000* 2) - ($50,000 * 2) = ($390,000) + ($13,000)

10X - $400,000 - $100,000 = ($403,000)

10x = ($403,000) + $500,000

x = $97,000/10

x = 9,700 units

Level of sales for two month period = 9,700 units

The level of sales for 2 months where Birch would be indifferent is 9,700 units.