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 $60 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	8.50
Direct labor		9.00
Variable manufacturing overhead		2.30
Fixed manufacturing overhead		7.00	($602,000 total)
Variable selling expenses		2.70
Fixed selling expenses		3.00	($258,000 total)
Total cost per unit	$	32.50

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 111,800 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 30% above the present 86,000 units each year if it were willing to increase the fixed selling expenses by $120,000. What is the financial advantage (disadvantage) of investing an additional $120,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 111,800 Daks each year. A customer in a foreign market wants to purchase 25,800 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $4.70 per unit and an additional $23,220 for permits and licenses. The only selling costs that would be associated with the order would be $2.30 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 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	Calculation of Financial Advantage / (Disadvantage)
	Selling Price Per Unit	60
	Less: total variable expense per unit	22.5
	Contribution margin per unit	37.5
	Increase in contribution margin	967500
	Less: Increase in selling expense(Fixed)	-120000
	Financial Advantage	847500
1-b	Yes, it is justified
2)	Computation of breakeven price per unit
	Direct material	8.5
	Direct labor	9
	variable manufacturing overhead	2.3
	Import Duties	4.7
	Permit Fees (Per Unit)	0.9
	Selling cost per unit	2.3
	Total Break even price per unit	27.7
3)	Unit cost for setting minimum selling price	2.7
	Note: variable selling cost will be the only relevant cost because other variable cost have already been incurred they are sunk cost now.
4)
	Units can be sold at given capacity	3583.333
	Contribution margin per unit	37.5
4) -a	Forgone Contribution margin	134375.00
4) -b	Total avoidable fixed cost	73816.67
4) -c	Financial Disadvantage	-60558.33
4) -d	No Plant should not be closed
		Annual Cost	Cost for 2 Months	cost which can be avoided
	Fixed manufacturing overhead	602000	100333.3	65,216.67
	fixed selling expenses	258000	43000	8,600.00
	Total avoidable cost			73,816.67
5)	Computation of Avoidable Cost per unit
	Direct material	8.5
	Direct labour	9
	variable manufacturing overhead	2.3
	Variable selling expense	0.90
	Saving in Fixed manufacturing oh cost per unit	2.1
	Total avoidable cost per unit	22.80