Question

Andretti Company has a single product called a Dak. The company normally produces and sells 60,000 Daks each year at a selling price of $32 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	10.00
Direct labor		4.50
Variable manufacturing overhead		2.30
Fixed manufacturing overhead		5.00	($300,000 total)
Variable selling expenses		1.20
Fixed selling expenses		3.50	($210,000 total)
Total cost per unit	$	26.50

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 90,000 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 25% above the present 60,000 units each year if it were willing to increase the fixed selling expenses by $80,000. What is the financial advantage (disadvantage) of investing an additional $80,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 90,000 Daks each year. A customer in a foreign market wants to purchase 20,000 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $1.70 per unit and an additional $9,000 for permits and licenses. The only selling costs that would be associated with the order would be $3.20 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 1,000 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 30% 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 60% 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 60,000 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 75%. 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

Requirement 1-a: Compute the financial advantage or disadvantage of investing in additional fixed costs as follows

Particulars	Amount
Incremental sales in units (60,000 units × 25%)	15,000
× Contribution margin per unit	$14.00
Incremental contribution margin	$210,000
Deduct: Fixed selling Expenses	$80,000
Financial advantage due to additional fixed costs	$130,000

Note: Compute contribution margin per unit as follows

Particulars	Amount	Amount
Selling Price per unit		$32.00
Deduct: Variable expenses per unit
Direct Material	$10.00
Direct Labor	$4.50
Variable Manufacturing Overhead	$2.30
Variable Selling Expenses	$1.20
Total Variable Expenses		$18.00
Contribution margin per unit		$14.00

Requirement 1-b: Yes because the company would generate an incremental income of $130,000.

Requirement 2: Compute break-even price per unit as follows

Particulars	Amount
Direct Material per unit	$10.00
Direct Labor per unit	$4.50
Variable Manufacturing Overhead per unit	$2.30
Import duties per unit	$1.70
Permits and Licenses per unit ($9,000 ÷ 20,000 units)	$0.45
Shipping costs per unit	$3.20
Break-even price per unit	$22.15

Requirement 3: The relevant unit cost is the variable selling cost per unit of $1.20 because all other already incurred variable manufacturing and fixed manufacturing and selling costs are sunk costs.

Requirement 4:

a. The lost contribution margin is $42,000

b. Total fixed costs avoided for the two months are $27,000 ($85,000 − $58,000)

c. The financial disadvantage of closing the plant is $15,000 ($58,000 − $43,000)

d. No, the company should not close the plant for the two months because the contribution from continuing the plant is $42,000.

Notes:

Particulars	Continue the Plant	Close the Plant
Sales ((60,000 × 2 months ÷ 12 months × 30%) × $32 per unit) (a)	$96,000	$0
Deduct: Variable expenses
Direct Material (60,000 × 2 months ÷ 12 months × 30%) × $10 per unit)	($30,000)	$0
Direct Labor   ($3,000 units × $4.50 per unit)	($13,500)	$0
Variable Manufacturing Overhead ($3,000 units × $2.30 per unit)	($6,900)	$0
Variable Selling Expenses ($3,000 units × $1.20 per unit)	($3,600)	$0
Total Variable Expenses (b)	($54,000)	$0
Contribution margin per unit (a) − (b)	$42,000	$0
Deduct: Fixed Costs
Fixed manufacturing overhead costs
($300,000 × 2 months ÷ 12 months)	($50,000)
($300,000 × 2 months ÷ 12 months) × 60%		($30,000)
Fixed selling costs costs
($210,000 × 2 months ÷ 12 months)	($35,000)
($210,000 × 2 months ÷ 12 months) × 80%		($28,000)
Total Fixed costs	($85,000)	($58,000)
Net operating loss	($43,000)	($58,000)

Requirement 5: Compute avoidable cost per unit as follows

Particulars	Amount
Direct Material	$10.00
Direct Labor	$4.50
Variable Manufacturing Overhead	$2.30
Variable Selling Expenses ($1.20 × 1 ÷ 3)	$0.40
Fixed manufacturing overhead ($300,000 × 75% ÷ 60,000 units)	$3.75
Total avoidable cost per unit	$20.95