Question

Andretti Company has a single product called a Dak. The company normally produces and sells 86,000 Daks each year at a selling price of $62 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	7.50
Direct labor		8.00
Variable manufacturing overhead		3.20
Fixed manufacturing overhead		7.00	($602,000 total)
Variable selling expenses		2.70
Fixed selling expenses		4.50	($387,000 total)
Total cost per unit	$	32.90

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 107,500 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 25% above the present 86,000 units each year if it were willing to increase the fixed selling expenses by $130,000. What is the financial advantage (disadvantage) of investing an additional $130,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 107,500 Daks each year. A customer in a foreign market wants to purchase 21,500 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $2.70 per unit and an additional $17,200 for permits and licenses. The only selling costs that would be associated with the order would be $2.20 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 30% 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 86,000 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

1 a). Assuming company's capacity to produce daks is 107500 each year.
Company could increase sales by 25%. ie. 86000*25% = 21500 units
Increase in fixed selling expenses = 130000.
Calculation of Contribution per unit:
Selling price                                    62
Less Variable Cost
       Direct Material                         7.5
       Direct Labour                            8
      Variable mfr overhead                3.2
      Variable selling overhead           2.7
Contibution per unit                        40.6

Total increase in contribution due to increase in units = 21500 * 40.6 = 872900
Increase in Fixed selling expenses                                                    130000
Net Advantage                                                                                 $742900

1 b). Yes, the additional investment is justified because it results in increase in profit by $7429000

2). Assuming company's capacity to produce daks is 107500 each year.
Calculating Total variable cost per unit for this order:
Variable Cost
       Direct Material                         7.5
       Direct Labour                            8
      Variable mfr overhead                3.2
      Variable selling overhead           2.2
Total Variable cost                        20.9
Additional costs:
Import duties = 21500 *2.7 = 58050
Licence                            = 17200
Total addition cost =             75250

Let the selling price be x . For breakeven this equation must be satisfied.
21500x - (21500*20.9) = 75250
21500x - 449350 = 75250
21500x = 524600
x = 24.4 i,.e breakeven selling price where profit is zero.

3). If company has 700 daks in hand which can't be sold at normal market price then , minimum relevant cost is the variable cost per unit i.e 7.5+8+3.2+2.7 = 21.4 . (here fixed cost is not relevant because it is unavoidable and hence sunk cost)

4).IF company works at 25% capacity for 2 months i.e 86000*25% = 21500/6 = 3583 daks
Contribution = 3583*40.6 =           145063.8
Fixed Costs:(602000+387000)/6 = 164833.33
Net loss = 145063.8-164833.33 = 19769.53

If company closes plant for 2 months:
Fixed Costs = Manufacturin = 602000*30% = 180600/6 = 30100
                      Selling = 387000*80% = 309600/6 = 51600
Total Fixed cost = 81700

a). Total contribution which company will forgo even closes plant for 2 months = 145063
b).Total Fixed costs if company will avoid if closed plant for 2 months:
Manufacturing = 602000/6*70% = 70233.33
Selling = 387000*20%/6 = 12900
Total Avoided cost = 83133.33
c).Financial disadvantage for closing the plant :
Loss due to closing the plant = 81700
Loss due to 25% working = 19769.53
Disadvantage = 81700-19769.53 = 61930.47
d).No. Company should not close the plant.

5). Avoidable cost per unit:
Variable cost per unit =   (7.5+8+3.2+2.7/3*2)= 20.5
Fixed mfr cost per unit = (602000*30%)/86000 = 2.1
Total avoidable cost per unit = 22.6 per unit