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

Question

Problem 9-8 Deciding Whether to Shut Down or Continue to Operate a Plant (LO1 - CC3) Birch Company normally produces and sells 38,500 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 $39 per unit, variable costs are $31 per unit, fixed manufacturing overhead costs total $192,500 per month, and fixed selling costs total $38,500 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 25,000 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 $134,750 per month and that fixed selling costs can be reduced by 10%. Startup costs at the end of the shutdown period would total $25,000. Since Birch Company uses just-in-time production methods, no inventories are on hand

Explanation / Answer

Req 1 Incremental analysis of Shutting down: Incremental revenue in for of savings Saving in fixed manufacturing cost (192500-134750)*2 115500 Saving in Selling OH (38500*10%)*2 7700 123200 Incremental cost Start up cost 25000 Loss of contribution (50,000 units @ 8) 400000 -425000 Net decrease in income -301800 No, Plant must not shut down. Req 2 Net savings in cost on shutting down Savings in fixed cost 123200 Less: Start up cost 25000 Net savings in cost on shutting down 98200 Number of units to be sold to be at indifference point: Savings in cost / Contribution per unit $ 98200 / 8 = 12,275units

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