Question

Andretti Company has a single product called a Dak. The company normally produces and sells 80,000 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	$	7.50
Direct labor		11.00
Variable manufacturing overhead		3.30
Fixed manufacturing overhead		5.00	($400,000 total)
Variable selling expenses		1.70
Fixed selling expenses		4.00	($320,000 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 96,000 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 20% above the present 80,000 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 96,000 Daks each year. A customer in a foreign market wants to purchase 16,000 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $2.70 per unit and an additional $12,800 for permits and licenses. The only selling costs that would be associated with the order would be $2.40 per unit shipping cost. What is the break-even price per unit on this order?

3. The company has 600 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 80,000 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

1-a.	Selling price				58
	Less: Variable cost
	Direct materials			7.5
	Direct labor			11
	Variable manufacturing overhead			3.3
	Variable selling expenses			1.7	23.5
	Contribution per unit				34.5
	Financial advantage of additional investment:
	Additional units produced				16000
	Contribution per unit				34.5
	Additional contribution				552000
	Less: Additional investment				130000
	Financial advantage				422000
1-b.	Additional investment is justified since there is a financial advantage of $ 422000
2	Break-even price=(Fixed cost/production volume)+Variable cost per unit
	Fixed cost=12800
	Variable cost per unit:
	Direct materials			7.5
	Direct labor			11
	Variable manufacturing overhead			3.3
	Variable selling expenses			2.4
	Import duties			2.7	26.9
	Break-even price=(12800/16000)+26.9=$ 27.7 per unit
3	Minimum selling price=Variable cost=$ 23.5 per unit
4a.	Contribution margin foregone=96000*25%*2/12*34.5=$ 138000
4b.	Fixed cost avoided:
	Fixed manufacturring overhead cost (400000*2/12*0.65)						43333
	Fixed selling expenses (320000*2/12*0.20)						10667
	Total						54000
4c.	Financial disadvantage:
	Contribution foregone						138000
	Less: Fixed cost avoided						54000
	Financial disadvantage						84000
4d.	Andretti should not close the plant since it results in a financial disadvantage of $ 84000
5	Avoidable cost per unit:
	Direct materials (80000*7.5)						675000
	Direct labor (80000*11)						880000
	Variable manufacturing overhead (80000*3.3)						264000
	Fixed manufacturing overhead cost (400000*0.30)						120000
	Variable selling expenses (80000*1.7*1/3)						45333
	Avoidable cost						1984333
	Units produced						80000
	Avoidable cost per unit						24.80