Question

Birch Company normally produces and sells 50,000 units of RG-6 each month. The selling price is $30 per unit, variable costs are $10 per unit, fixed manufacturing overhead costs total $170,000 per month, and fixed selling costs total $42,000 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 12,000 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 $45,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $15,000. Because Birch Company uses Lean Production methods, no inventories are on hand. Required: 1. What is the financial advantage (disadvantage) if Birch closes its own plant for two months? 2. Should Birch close the plant for two months? 3. At what level of unit sales for the two-month period would Birch Company be indifferent between closing the plant or keeping it open?

Answer 1

Answer 1.
Contribution Margin Lost by Closing of Plant - 12,000 Units X $20 X 2 Months	(480,000.00)
Cost Avoided by Closing of Plant:
Fixed Manufacturing Costs - $45,000 X 2 Months	90,000.00
Fixed Selling Expense - $42,000 X 2 Months X 10%	8,400.00
Net Disadvantage of Closing before start-up Costs	(381,600.00)
Start-up Costs	15,000.00
Disadvantage of Shuting down of Plant	(396,600.00)
Net Income will be reduced by $396,600, if plant is shut down.
Answer 2.
No, the Birch should not shut down its plant
Answer 3.
Contribution per Unit = $30 - $10 = $20
Cost avoided by Closing down of Plant	98,400.00
Start-up Costs	(15,000.00)
Total avoidable Costs	83,400.00
Contribution per Unit	20.00
No. of Units at which Birch Company is indifferent	4,170.00