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 $42 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	9.50
Direct labor		11.00
Variable manufacturing overhead		1.90
Fixed manufacturing overhead		6.00	($504,000 total)
Variable selling expenses		4.70
Fixed selling expenses		6.50	($546,000 total)
Total cost per unit	$	39.60

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 100,800 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 20% above the present 84,000 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 100,800 Daks each year. A customer in a foreign market wants to purchase 16,800 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $4.70 per unit and an additional $13,440 for permits and licenses. The only selling costs that would be associated with the order would be $2.70 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 800 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

In order to answer the questions of each part, first of all analyse the present scenario and arrive at figures for further reference / computation:

Particulars	Amount in $ at 84,000 Daks Capacity of production
Direct Materials per unit	9.50
Direct labor per unit	11.00
Variable manufacturing overhead per unit	1.90
Total Variable manufacturing expenses per unit	22.40
Total Variable manufacturing expenses (22.40 x 84000)	18,81,600
Selling price per unit	42.00
Sales value (42 x 84000)	35,28,000
Gross contribution margin (3528000 - 1881600)	16,46,400
Variable selling expenses per unit	4.70
Variable selling expense for total units	3,94,800
Total Variable expense	22,76,400
Contribution margin (1646400 - 394800)	12,51,600
Fixed manufacturing overhead	5,04,000
Fixed selling expense	5,46,000
Total fixed expense (504000 +546000)	10,50,000
Net profit (contribution margin - fixed expenses = 1251600 - 1050000)	2,01,600
Gross contribution per unit (1646400/84000)	19.60
Contribution margin per unit (12,51,600/84000)	14.90
Net profit % (net profit / sales %)	5.71%

1.a. If unit sales increase by 20% and fixed selling price increases by $ 120000.

Contribution margin per unit remain same as computed earlier = $ 14.90

Contribution for total 100800 units = $14.90 x 100800 = $ 15,01,920

Total fixed expenses = fixed manufacturing overhead (remains same as earlier) + fixed selling expense = $ 504000+ $ 546000 + $ 120000 = $1170,000

Net profit at 100800 units = $15,01,920 - $11,70,000= $331920

Net profit % = $ 331920 / (42 x 100800) % = 7.84 %

Conclusion : By investing an additional amount of $120000 to existing fixed selling expenses will enable Andretti company to produce 100800 units of capacity and there by earning an additional profit of 2.13 % from the exisitng sitution. So it is financially advantage to the organisation.

1.b. The additional investment is justifiable as calculated above. it can be seen that an additional profit is earning by the organisation for $130320 ( $ 331920- $201600). Further company is not required to spend any additional fixed manufacturing overheads for prdoucing this additional units. Hence it is feasible if company is investing in the additional fixed selling expenses and increasing its production capacity.

2. Computation of Break even price per unit on foreign order

Foreign order = 16,800 DAKs

Import duty = $ 4.70 per unit = $78,960

Cost of permits and license = $13,440

Shipping cost =$ 2.7 per unit = $45,360

Total fixed expenses at 100800 units (calculated as above) = $ 1170,000

Fixed expenses per unit = $1170,000/100800 units = $11.61

If the foreign order is accepted, the total fixed and variable expenses for that order = $78960 + $13440 + $45360 + ($11.60 x 16800 units) + ( variable expenses $ 27.10 x 16800 units) = $ 787920

Therefore, break even price per unit on this order = $ 787920 /16800 units = $46.90

That means , break even price is no profit no loss situation, hence the minimum selling price to be charged for this foreign order and any price per unit below this will not be feasible.

3. Assuming the 800 Daks on hand is at 100800 units capacity.

As said in the question, it is not able to sell this 800 Daks at normal price due to irregularities, then while settling the selling price the minimum amount means is the break even price per unit ie no profit and no loss situation. At 100800 units capacity, total fixed costs = $11,70,000

total variable cost per unit = $ 27.1

Total cost for 800 units = ($ 27.1 x 800) +((11,70,000/ 100800) x800)= $30,968

Break even per unit for 800 units = $38.71

Minimum selling price = $38.71

4. If company is close down its plant

Fixed manufacturing overhead = 35% of overhead at normal level over two months = ($ 504000 x 35% ) 2 /12 = $29400

Fixed selling expenses = 80 % of expenses at normal level over two months = ($ 546000 x 80%) 2/12 = $72800

a. contribution margin forgone if plant is closed down

Contribution margin forgone = $ 14.90 x units @ 25 % over the two month period = $ 14.90 X (21000 units x 2/12)= $52,150

b. Avoidable fixed cost if company is closed down = total fixed cost for two months - unavoidable fixed costs for two months =[ (504000+546000)2/12] -[29400 + 72800] = $ 72800

c. Financial advantage of closing down for two months is the company can able to avoid fixed expense of $ 72800 and if it is run for two months the only contribution received will be $52150, which is less than the amount that can be avoided if plant is closed down. Hence its better for the company to close down the plant for two months.

d. As mentioned above , it can be seen that company will be benefitted if plant is closed down for two months rather than running the plant at 25 % capacity which is justified in above calculations.