Question

Andretti Company has a single product called a Dak. The company normally produces and sells 83,000 Daks each year at a selling price of $56 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	8.50
Direct labor		11.00
Variable manufacturing overhead		2.90
Fixed manufacturing overhead		9.00	($747,000 total)
Variable selling expenses		2.70
Fixed selling expenses		3.00	($249,000 total)
Total cost per unit	$	37.10

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 103,750 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 25% above the present 83,000 units each year if it were willing to increase the fixed selling expenses by $110,000. What is the financial advantage (disadvantage) of investing an additional $110,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

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?

Answer 1

	Contribution margin
	selling price per unit				56
	less Variable expenses
	direct materials			8.5
	direct labor			11
	Variable manufacturing overhead			2.9
	variable selling expense			2.7	25.1
	Contribution margin per unit				30.9
Req 1A	increased sales in units			(83000*25%)		20750
	contribution margin per unit					30.9
	incremental contribution margin					641175
	less added fixed selling expense					110,000
	incremental net operarting income					531,175
1-b)	Yes

4)	Foregone contribution margin			(3458*30.9)				106852.20
	total avoidable fixed cost
	fixed manufacturing overhead cost				(747000*2/12)*65%		80925
	fixed selling cost				(249000*2/12)*20%		8300	89225.00
	Financial disadvantage							-17627.20
	83000*2/12*25%=			3458.333	units
	No