Problem 9-8 Deciding Whether to Shut Down or Continue to Operate a Plant (LO1 CC

Question

Problem 9-8 Deciding Whether to Shut Down or Continue to Operate a Plant (LO1 CC3) Birch Company normally produces and sells 35,000 units of RG-6 each month. RG-6 is a small electrical relay used in the automotive industry as a component part in various products. The selling price is $32 per unit, variable costs are $24 per unit, fixed manufacturing overhead costs total $175,000 per month, and fixed selling costs total $35,000 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 18,000 units per month. Birch Company estimates that the strikes will last for about two months, after which time sales of RG-6 should return to normal. Due to the current low level of sales, however, Birch Company is thinking about closing its own plant during the two months that the strikes are on. If Birch Company does close its plant, it is estimated that fixed manufacturing overhead costs can be reduced to $122,500 per month and that fixed selling costs can be reduced by 10%. Startup costs at the end of the shutdown period would total $18,000. Since Birch Company uses just-in-time production methods, no inventories are on hand. Required 1-a. Assuming that the strikes continue for two months, compute the increase or decrease in income from closing the plant. in income

Explanation / Answer

2 months 1 18000 units sales Shut down Sales revenue 1152000 0 Expenses Variable cost 864000 0 Fixed manufacturing cost 350000 245000 Fixed selling cost 70000 63000 Startup cost 0 18000 Total expense 1284000 326000 Net operating profit / (loss) -132000 -326000 Decrease in income by -194000 2 No as shutdown will lead to more loss 3 units in sales level = (Fixed cost -net operating loss) / contribution margin Fixed cost 420000 Net operating loss -326000 Total 94000 Contribution margin 8 Units in sales level for 2 months 11750 Units

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