Question

Birch Company normally produces and sells 46,000 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 $25 per unit, variable costs are $17 per unit, fixed manufacturing overhead costs total $170,000 per month, and fixed selling costs total $38,000 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 11,000 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 $40,000 per month and its fixed selling costs by 9%. 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:

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.) (Round your final answer to the nearest whole number.)

Answer 1

Solution 1a:

Differential Analysis - Birch Company - Continue plant for 2 months (alt 1) or Shutdown plant for 2 months (Alt2)
Particulars	Continue plant for 2 months (Alt 1)	Shut down plant for 2 months (Alt 2)	Financial advantage (Disadvantage) of shutdown (Alternative 2)
Revenue	$550,000.00	$0.00	-$550,000.00
Costs:
Variable cost	$374,000.00	$0.00	-$374,000.00
Fixed manufacturing overhead cost	$340,000.00	$260,000.00	-$80,000.00
Fixed selling cost	$76,000.00	$69,160.00	-$6,840.00
Startup cost at the end of shutdown period	$0.00	$14,000.00	$14,000.00
Income / (Loss)	-$240,000.00	-$343,160.00	-$103,160.00

Solution 1b:

As there is financial disadvantage of $103,160 on closing the plant, therefore Birch company should not close the plant.

Solution 2:

Let at x units level for sale for two month period Birch company be indifferent between closing the plant and keeping it open.

Therefore net income at X units under continue plant and closing the plant will be same.

Net income from closing the plant = -$343,160

25X - 17X - $340,000 - $76,000 = -$343,160

8X = $72,840

X = 9105 units

Hence at 9105 units company will be indifferent between closing the plant and keeping it open.