Question

Birch Company normally produces and sells 40,000 units of RG-6 each month. RG-6 is a small electrical relay used in the automotive industry as a component part in various products. The selling price is $42 per unit, variable costs are $34 per unit, fixed manufacturing overhead costs total $200,000 per month, and fixed selling costs total $40,000 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 28,000 units per month. Birch Company estimates that the strikes will last for about two months, after which time sales of RG-6 should return to normal. Due to the current low level of sales, however, Birch Company is thinking about closing its own plant during the two months that the strikes are on. If Birch Company does close its plant, it is estimated that fixed manufacturing overhead costs can be reduced to $140,000 per month and that fixed selling costs can be reduced by 10%. Startup costs at the end of the shutdown period would total $28,000. Since Birch Company uses just-in-time production methods, no inventories are on hand.

1-a.	Assuming that the strikes continue for two months, compute the increase or decrease in income from closing the plant ______(increase/decrease)____in income $___________

2.	At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant and keeping it open? Level of sales _______units

Answer 1

Solution 1:

Differential Analysis - 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)	Increase (Decrease) in income of shutdown (Alternative 2)
Revenue (28000*2*$42)	$23,52,000.00	$0.00	-$23,52,000.00
Costs:
Variable cost (28000*2*34)	$19,04,000.00	$0.00	-$19,04,000.00
Fixed manufacturing overhead cost	$4,00,000.00	$2,80,000.00	-$1,20,000.00
Fixed selling cost	$80,000.00	$72,000.00	-$8,000.00
Startup cost at the end of shutdown period	$0.00	$28,000.00	$28,000.00
Income / (Loss)	-$32,000.00	-$3,80,000.00	-$3,48,000.00

Decrease in income $348,000.

Solution 2:

Level of sales to be indifferent = (Avoidable Fixed Cost - Startup cost) / Contribution margin per unit

= ($120000 + $80000 - $28000) / ($42- $34)

= $100000 / $8

= 12,500 units