Question

Andretti Company has a single product called a Dak. The company normally produces and sells 87,000 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	$	8.50
Direct labor		9.00
Variable manufacturing overhead		2.80
Fixed manufacturing overhead		5.00	($435,000 total)
Variable selling expenses		3.70
Fixed selling expenses		3.50	($304,500 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 121,800 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 40% above the present 87,000 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 121,800 Daks each year. A customer in a foreign market wants to purchase 34,800 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $3.70 per unit and an additional $27,840 for permits and licenses. The only selling costs that would be associated with the order would be $2.60 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 87,000 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

Normal Capacity = 87,000 units

Selling Price per unit = $62 per unit

Direct materials	$	8.50
Direct labor		9.00
Variable manufacturing overhead		2.80
Fixed manufacturing overhead		5.00	($435,000 total)
Variable selling expenses		3.70
Fixed selling expenses		3.50	($304,500 total)
Total cost per unit	$	32.50

Total Variable cost per unit = 8.50 + 9.00 + 2.80 + 3.70 = $24 per unit.

Total variable cost = $24*87000 units = $2,088,000

Total Fixed cost = $435.000+$304,500 = $ 739,500

Total Sales Revenue = 87,000 units * $62 =  $5,394,000

Profit at present level = $5,394,000 - ($2,088,000+$739,500) = $2,566,500

Q1-a).

Current level of Sale = 87,000 units.

No of units the company intends to sell during the year = 87,000 + 40% = 121,800 units

Additional fixed selling expenses for the company = $120,000

Total Cost = ($24*121,800 units)+$739,500+$120,000 = $3,782,700

Total sales revenue = 121,800 units * $62 = $7,551,600

Profit at proposed level = $3,768,900

The financial advantage = Profit at new level (121,800 units) - Profit at normal level (87,000 units)

= $3,768,900 - $2,566,500

= $1,202,400

Q1b)
As we could see, the the total profit increase by $1,202,400 despite the charge of extra fixed selling overheads of $120,000. This shows that the company has an advantage by selling more by incurring extra cost.

Q2.  

Assuming that the question is asking for the break-even price for the foreign order of 34,800 Daks:

Maximum capacity of the company = 121,800 units
Normal level of operation = 87,000 units
New foreign order = 34,800 units

For 34,800 Deks (Foreign Order) :

Normal variable cost = ($8.5 + $9 + $2.8+ $2.6) * 34.800 units = $ 796,920
Import Duties = $ 3.70 * 34,800 units = $ 128,760
Permit and Licenses = = $ 27,840

Total Cost for 34,800 units = $ 953,520
No of Units = 34,800 units

Break-even SP for each unit = $ 27.40 per unit

Q3.

It is mentioned that 700 Deks have few irregularities due to which the same cannot be sold at the normal selling price. Hence the company should fix a price below the normal selling price to make those goods sold, which are under the category "seconds".

While fixing the minimum selling price for the goods under seconds category, the company should ensure that the variable costs related to the goods produced could be realised from the sale of those goods. In the current scenario, the relevant variable costs are Direct materials costing $8.50 per unit, Direct labor costing $9 per unit, Variable manufacturing overhead costing $2.80 per unit, and Variable selling expenses costing $3.70 per unit.

Therefore, the per unit cost relevant for setting the minimun SP = $8.50+$9.00+$2.80+$3.70 = $ 24.00 per unit

We didn't consider fixed costs because, the same is incurred irrespective of the number of units produced. Hence, if the total good output is 86,300 units (87,000-700) or 87,000, the same amount of fixed cost is incurred.

Q4

Normal annual sales = 87,000 units
Normal monthly sales = 87,000 units/ 12 months = 7,250 units

Total sales during the year if the company operate = (7,250 units *10 months) + (7,250 * 25% * 2 months) = 76,125 units

Q4a)
Contribution per unit = Sales Price per unit- Variable cost per unit = $62 - $24 = $38
No of units produced if the plant is operated for 12 months = 76,125 units
No of units produced if the plant is operated for 10 months = 72,500 units

Contribution margin if the plant is working for 12 months = 76,125 units * $38 = $2,892,750   
Contribution margin if the plant is working for 10 months = 72,500 units * $38 = $2,755,000

Hence, Contribution margin lost = $ 137,750

Q4b)

Fixed manufacturing overhead for the year (12 months) = $435,000
Fixed manufacturing overhead for 1 month = $435,000/12 = $36,250
Fixed manufacturing overhead if plant is shut = ($36,250 * 10 months) + ($36,250 * 35% * 2 months) = $ 387,875

Fixed selling expenses for the year (12 months) = $304,500
Fixed selling expenses for 1 month = $435,000/12 = $25,375
Fixed selling expenses if plant is shut = ($25,375 * 10 months) + ($25,375 * 80% * 2 months) = $ 294,350

Normal Total Fixed Cost =$ 739,500
Fixed cost when plant is shut =$ 682,225

Therefore, savings in Fixed Cost when plant is shut = $ 57,275

Q4c)

When the Plant is working for all 12 months:

Contribution margin if the plant is working for 12 months = 76,125 units * $38 = $ 2,892,750   (From Q4a)
Total fixed cost = $ 739,500 (From Q4b)
Therefore, Profit for the year if plant is open for 12 months   = $ 2,153,250

Contribution margin if the plant is working for 10 months = 72,500 units * $38 = $2,755,000 (From Q4a)
Total fixed cost = $ 682,225 (From Q4b)
Therefore, Profit for the year if plant is open only for 10 months   = $ 2,072,775

Hence the financial disadvantage if the plant is shut = $ 2,153,250 - $ 2,072,775 = $ 80,475

Q4d)
Therefore we can conclude that, since the net benefit is negative ( or the company is getting a financial disadvantage), the plant shouldn't be shut. Rather, the plant should operate throughout the year.

Plant should operate at 100% capacity for 10 months and at 25% capacity during the remaining 2 months.