Question

Andretti Company has a single product called a Dak. The company normally produces and sells 89,000 Daks each year at a selling price of $58 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		3.20
Fixed manufacturing overhead		9.00	($801,000 total)
Variable selling expenses		2.70
Fixed selling expenses		3.00	($267,000 total)
Total cost per unit	$	35.40

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 115,700 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 30% above the present 89,000 units each year if it were willing to increase the fixed selling expenses by $130,000. What is the financial advantage (disadvantage) of investing an additional $130,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 115,700 Daks each year. A customer in a foreign market wants to purchase 26,700 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $3.70 per unit and an additional $21,360 for permits and licenses. The only selling costs that would be associated with the order would be $2.50 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 89,000 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

Answer 1-a.
Calculation of Incremental Net Income
Increase Sales In Units - 89,000 X 30%	26,700
Contribution Margin Per Unit	34.60
Incremental Contribution Margin	923,820
Less: Increase in Fixed Selling Exp.	(130,000)
Increase (Decrease) in Net Income	793,820
SP per Unit		58.00
Less: Variable Expenses
Direct Materials	8.50
Direct Labor	9.00
Variable MOH	3.20
Variable Selling Exp.	2.70	23.40
Contribution Per Unit		34.60
Answer 1-b.
Yes, increased in fixed selling expenses is justified, as Net Profit will increased by $793,820
Answer 2.
Price per Unit:
Direct Materials	8.50
Direct Labor	9.00
Variable MOH	3.20
Variable Selling Exp. (shipping Cost)	2.50
Import duties	3.70
Permit & License - $21,360 / 26,700 Units	0.80
BEP per Unit	27.70
Answer 3.
Variable Selling Exp. = $2.70 per unit is only relevant cost.
Since the irregular units have already been produced, all production costs (including the variable production costs) are sunk. The fixed selling expenses are not relevant since they will not change regardless of whether or not the irregular units are sold.
Answer 4.
Continuing Production
Daks Produced in case of Strike = (89,000 Units X 2/12) X 25% = 3,708.33 or say 3,708 Units (Approx.)
Contribution Margin Lost - 3,708 Units X $34.60		128,297
Fixed Cost
Fixed Manufacturing Cost - $801,000 X 2/12 X 65%	86,775
Fixed Selling Cost	8,900	95,675
Net Disadvantage of Closing the plant		32,622
Shutting down the plant would cause a decrease in net income of $32,622
Therefore, the plant should continue to produce at the 25% production level.
Answer 5.
Direct Material	8.50
Direct Labor	9.00
Variable MOH	3.20
Variable Selling Exp. - $2.70 X 1/3	0.90
Fixed MOH - ($801,000 X 30%) / 89,000 Units	2.70
Total Cost Avoided	24.30