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

Question

Problem 9-8 Deciding Whether to Shut Down or Continue to Operate a Plant (LO1- CC3) Birch Company normally produces and sells 40,000 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 $42 per unit, variable costs are $34 per unit, fixed manufacturing overhead costs total $200,000 per month, and fixed selling costs total $40,000 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 28,000 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 $140,000 per month and that fixed selling costs can be reduced by 10%. Startup costs at the end of the shutdown period would total $28,000. 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 1-b. Would you recommend that Birch Company close its own plant? Yes No

Explanation / Answer

Altrnative-1: Running the Plant with Sales of 28000 Unit/month Alternative-2: Closing Down th plant Selling Price/Unit $42.00 Fixed Manufacturing Overhead for 2 Month ($140000*2) $280,000 Variable Cost/Unit $34.00 Fixed Selling Expense for 2 Month ($36000*2) $72,000 Contribution Margin $8.00 Less: Startup Cost would be incurred -$28,000.00 Contribution Earned by Sales of 28000 Unit $448,000.00 (28000 Unit* 2 Month *$8) Total Loss Incurred by closing Down the plant $324,000 Fixed Manufacturing Overhead Cost $400,000.00 Fixed Selling Cost $80,000.00 Impact on Profit Net Loss -$32,000.00 Net loss in Operating Plant $32,000.00 Loss Incurred by Closing Down the plant $324,000.00 Net disadvantage of Closing down the plant -$292,000.00 1.Impact on Income on Closing down the plant is net income decreased by $292000 in two Month. 1. b As per above analysis, it is not recommended to closing the plant by Birch Company. Part-2 Level of Sales Unit to be indifferent b/w 2 option Let Asume the level of Sales ( units) X Fixed Manufacturing Overhead (a) 200000 Fixed Selling Expense(b) 40000 Fixed Cost (a+b) 240000 Contribution Margin Per Unit $8 Total Conntibution for X Unit $8X Total Loss incurred by Closing Down the plant $324,000 $240000-8X=324000 X=84000/8= 10500 Unit for 2 Month For 1 Month = 10500/2 = 5250 Unit

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