Birch Company normally produces and sells 47,000 units of RG-6 each month. RG-6
ID: 2461860 • Letter: B
Question
Birch Company normally produces and sells 47,000 units of RG-6 each month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is $26 per unit, variable costs are $20 per unit, fixed manufacturing overhead costs total $180,000 per month, and fixed selling costs total $30,000 per month.
Employment-contract strikes in the companies that purchase the bulk of the RG-6 units have caused Birch Company’s sales to temporarily drop to only 13,000 units per month. Birch Company estimates that the strikes will last for two months, after which time sales of RG-6 should return to normal. Due to the current low level of sales, Birch Company is thinking about closing down its own plant during the strike, which would reduce its fixed manufacturing overhead costs by $60,000 per month and its fixed selling costs by 9%. Start-up costs at the end of the shutdown period would total $13,000. Because Birch Company uses Lean Production methods, no inventories are on hand.
At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant or keeping it open?
Birch Company normally produces and sells 47,000 units of RG-6 each month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is $26 per unit, variable costs are $20 per unit, fixed manufacturing overhead costs total $180,000 per month, and fixed selling costs total $30,000 per month.
Explanation / Answer
1a.
Contribution margin per unit of RG-6 = Selling price – Variable cost = $26 - $20 = $6 per unit
If the strike continues,
Sales quantity per month = 13,000 units
Contribution margin during strike period = ($6 * 13,000 units) * 2 months = $156,000
If the plant is closed, this contribution margin will be lost. However, the company will be able to avoid certain fixed costs as a result of closing down. The analysis is:
Contribution margin lost by closing the plant for two months
($6 per unit × 13,000 units * 2 months)
$156,000
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost
$60,000 per month × 2 months
$120,000
Fixed selling costs
($30,000 per month × 9% × 2 months)
$5,400
Net Loss of income
$30,600
Startup cost after 2 months
$13,000
Net impact of income by closing the plant
$43,600
1b.
No, the company should not close the plant; it should continue to operate at the reduced level of 13,000 units produced and sold each month. Closing will result in a $43,600 greater loss over the two-month period than if the company continues to operate. An additional factor is the potential loss of goodwill among the customers who need the 13,000 units of RG-6 each month. By closing down, the needs of these customers will not be met (no inventories are on hand), and their business may be permanently lost to another supplier.
2.
Cost avoided by closing the plant for two months = Avoidable fixed manufacturing costs + Avoidable fixed selling expenses = $120,000 + $5,400 = $125,400
Net avoidable costs = $125,400 – Startup costs = $125,400 - $13,000 = $112,400
Indifference level of sales = Net avoidable cost / Contribution margin per unit = $112,400 / $6 = 18,733
Contribution margin lost by closing the plant for two months
($6 per unit × 13,000 units * 2 months)
$156,000
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost
$60,000 per month × 2 months
$120,000
Fixed selling costs
($30,000 per month × 9% × 2 months)
$5,400
Net Loss of income
$30,600
Startup cost after 2 months
$13,000
Net impact of income by closing the plant
$43,600
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