Question

Birch Company normally produces and sells 48,000 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 $26 per unit, variable costs are $16 per unit, fixed manufacturing overhead costs total $155,000 per month, and fixed selling costs total $48,000 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 9,000 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 12%. Start-up costs at the end of the shutdown period would total $12,000. 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?
	No Yes

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?

    

Answer 1

1a. Closing of the plant will not generate revenue, nor will incurr any variable and selling cost. Only expenditure would be the Fixed overhead. Therefore, company would incurr a loss of 50000 per month for 2 months.

1b. If the plant is not closed and company sales the reduced 9000 units, then the income would be :

Sales (9000 units @26)	234,000
Variable cost @ 16	144,000
Fixed manufacturing cost	50,000
Fixed selling cost	42,240
Net Income per month	(2,240)
Strike for 2 months, therefore next income for 2 months	(4,480)

It is better to produde and sell reduced units rather than closing out the plant.

2.

Indifference point	Differential fixed cost/ variable cost per unit
	(155000 + 48000-42240 -50000)/16
	6,922.50 per month