Question

Andretti Company has a single product called a Dak. The company normally produces and sells 84,000 Daks each year at a selling price of $64 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	9.50
Direct labor		10.00
Variable manufacturing overhead		2.10
Fixed manufacturing overhead		6.00	($504,000 total)
Variable selling expenses		3.70
Fixed selling expenses		4.00	($336,000 total)
Total cost per unit	$	35.30

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 109,200 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 30% above the present 84,000 units each year if it were willing to increase the fixed selling expenses by $110,000. What is the financial advantage (disadvantage) of investing an additional $110,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 109,200 Daks each year. A customer in a foreign market wants to purchase 25,200 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $2.70 per unit and an additional $17,640 for permits and licenses. The only selling costs that would be associated with the order would be $1.80 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 700 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 25% 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 35% 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 84,000 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 30%. 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

	Contribution margin
	selling price per unit				64
	less Variable expenses
	direct materials			9.5
	direct labor			10
	Variable manufacturing overhead			2.1
	variable selling expense			3.7	25.3
	Contribution margin per unit				38.7
Req 1A	increased sales in units			(84000*30%)		25200
	contribution margin per unit					38.7
	incremental contribution margin					975240
	less added fixed selling expense					110,000
	incremental net operarting income					865,240
1-b)	Yes
Req 2	Break even price per unit
	Variable manufacturing cost per unit			21.6		(DM+DL+VOH)
	Shipping cost			1.8
	import duties			2.7
	permits &licences			0.7
	Break even price per unit			26.8	answer
Req 3	Relevant unit cost		$3.70	per unit
	(only selling expense will be incurred to sell irregualr units, rest is sunk cost)
4)	Contribution margin lost			(3500*38.70)				-135450
	fixed costs
	fixed manufacturing overhead cost				(504,000*2/12)*65%		54600
	fixed selling cost				(336,000*2/12)*20%		11200	65800
	net advantage of closing the plant							-69650
	84,000*25%*2/12=			3500	units
	no
5)	Variable manfuacturing costs						21.6
	fixed manufacturing overhead cost				(4*30%)=		1.2
	variable selling expense				3.7*1/3		1.23
	total costs avoided						24.03