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 $54 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	7.50
Direct labor		8.00
Variable manufacturing overhead		2.90
Fixed manufacturing overhead		9.00	($747,000 total)
Variable selling expenses		4.70
Fixed selling expenses		3.50	($290,500 total)
Total cost per unit	$	35.60

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 99,600 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 20% above the present 83,000 units each year if it were willing to increase the fixed selling expenses by $130,000. What is the financial advantage (disadvantage) of investing an additional $130,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 99,600 Daks each year. A customer in a foreign market wants to purchase 16,600 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $3.70 per unit and an additional $8,300 for permits and licenses. The only selling costs that would be associated with the order would be $2.20 per unit shipping cost. What is the break-even price per unit on this order?

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 30% 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?

5. An outside manufacturer has offered to produce 83,000 Daks and ship them directly to Andretti’s customers. If Andretti Company accepts this offer, the facilities that it uses to produce Daks would be idle; however, fixed manufacturing overhead costs would be reduced by 30%. Because the outside manufacturer would pay for all shipping costs, the variable selling expenses would be only two-thirds of their present amount. What is Andretti’s avoidable cost per unit that it should compare to the price quoted by the outside manufacturer?

Answer 1

Firstly, calculate contribution margin per unit as follows:

Selling price per unit (A)	$ 54
Variable cost per unit as
Direct materials	7.50
Direct labor	8.00
Variable manufacturing overhead	2.90
Variable selling expenses	4.70
Total variable cost per unit(B)	23.1
Contribution margin per unit (A-B)	$ 30.9

1a. The incremental operating income shall be computed as:

Incremental contribution margin {16,600 units*30.9}	$ 512,940
Incremental fixed costs	$ 130,000
Incremental net income	$ 382,940

Incremental units = 99,600-83000 = 16,600 units

The financial advantage of investing an additional amount in fixed selling expenses is $ 724,000

1b. Yes, the cost is justified as incremental contribution is more than enough to cover for the incremental fixed selling expenses.

2. The breakeven price will not include current fixed costs as the order will be only for the incremental costs of the units i.e. variable cost as

Variable cost per unit as
Direct materials	7.50
Direct labor	8.00
Variable manufacturing overhead	2.90
Variable selling expenses (i.e. shipping cost only)	2.2
Import duties	3.70
Permits and licenses (8,300/16,600)	0.5
Breakeven cost for order	$ 24.8

3.The company has already incurred manufactured costs on these 600 daks. So, these costs are sunk costs and irrelevant. These items cannot be sold through normal distribution channels. Hence, selling expenses cannot be relevant here as the different channel is to be used for selling these seconds. Hence. The relevant cost should be any selling price

4. Calculate difference between two alternatives as:

	Keep open	Close
Contribution margin	13,833.33 * 25% *30.9 = $ 106,862.5	NIL
Fixed costs per two months as:
Manufacturing overhead	747,000*2/12 = $ 124,500	30% of $ 124,500 = $ 37,350
Selling expenses	3.50 * 13,833.33 =$ 48,416.67	48,416.65* 80% = $ 38,733.33
Total fixed costs	$ 172,916.67	$ 76,083.33
Net operating income (loss) for two months	($ 66,054.17)	( $ 76,083.33)

While keeping the operations open,

Number of units in 2 months = 83,000 *2/12 =13,833.33 units

1. Total contribution foregone would be $ 106,862.5
2. Total fixed cost company avoids if it closes is $ 172,916.67-76,083.33 = $96,833.34
3. The financial disadvantage of closing the plant would be 76,083.33-66,054.17= $ 10,029.16
4. Andretti should keep open the plant as there would be advantage of 10,029.16 for keeping open

5.

Variable cost per unit as
Direct materials	$ 7.50
Direct labor	8.00
Variable manufacturing overhead	2.90
Variable selling expenses (incremental part would be one-third portion only)	1.23 (3.70/3)
Total variable cost per unit	19.63
Add: Avoidable fixed manufacturing overhead	6.3 (9*70%)
Relevant cost per unit	$ 25.93

Hence, Andretti shall compare $ 25.93 to the price quoted by outside manufacturer.