Question

Problem 11-18 Relevant Cost Analysis in a variety of Situations (LO11-2, LO11-3, LO11-4] Andretti Company has a single product called a Dak. The company normally produces and sells 120,000 Daks each year at a selling price of $48 per unit. The company's unit costs at this level of activity are given below: 2.70 Direct materials $ 8.50 Direct labor 11.00 Variable manufacturing overhead Fixed manufacturing 60 ($ 720,000 overhead total) Variable selling expenses 4.70 Fixed selling expenses total) Total cost per unit $38.40 5.50 ($660,000 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 150,000 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 25% above the present 120,000 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 150,000 Daks each year. A customer in a foreign market wants to purchase 30,000 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $3.70 per unit and an additional $21,000 for permits and licenses. The only selling costs that would be associated with the order would be $1.90 per unit shipping cost. What is the break-even price per unit on this order? 3. The company has 700 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 120,000 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

Solution:
1a.
Current Sale	120000
Proposed Increase	25%
Proposed Increase in unit	30000	(120000 X 25%)
Selling Price per unit	48
Extra revenue	1440000	(30000 X 48)
.
Total Variable Cost per unit	26.9	(8.50 + 11 + 2.70 + 4.70) Haven't considered fixe manufacturing overhead and fixed selling expense
Additional Variable Cost	807000	(30000 X 26.90)
Net Increase in revenue	633000	(1440000 - 807000)
Additional Selling expense	130000
Advantage	503000	(633000 - 130000)
The company earns additional net income of 503000 so it is worth going ahead with this
1b- Justification of additional investment
The company net incremental revenue by this is $633,000 (Selling price less variable cost) and the increase in fixed expense is only $130,000 and
hence it justified additional investment
2. let's look at the additional cost of this order of 30,000
Import duty	111000	(30000 X 3.70)
Permits and license	21000
Additional selling cost	57000	(30000 X 1.90)
Total of additional cost	189000
Existing variable cost	807000	(30000 X 26.90 as calculated in 1a above)
Total cost of 30,000 order	996000	(189000 + 807000)- ignoring fixed cost as that doesn’t changes with this order
Total unit	30000
Break even	33.2	(996000 / 30000)
The company needs to recover $ 33.20 per unit in order to break even on this order of 30,000 units
3. The variable unit cost of 26.90 is relevant which should be the minimum selling price. The fixed cost doesn’t change with the change in output
4a
Total Capacity in unit	120000
Capacity per month	10000
Normal capacity for 2 months	20000
Selling price	48
Variable cost	26.9
Contribution per unit	21.1
Total net revenue lost	422000	(21.10 X 20000)
Fixed manufacturing over	36000	(720000/ 12) X 2 X 30% as it will continue to be 30% only if plant shut down
Normal fixed manufacturing over	120000	(720000/ 12) X 2 if plant continues
Saving in fixed manf over	84000	(120000 - 36000)
Saving in fixed selling	22000	(660000/12 X 2) X 20%
Total Saving	106000	(84000 + 22000)
Net Contribution lost	316000	(422000 - 106000)
4b
Fixed manufacturing over	36000	(720000/ 12) X 2 X 30% as it will continue to be 30% only if plant shut down
Normal fixed manufacturing over	120000	(720000/ 12) X 2 if plant continues
Saving in fixed manf over	84000	(120000 - 36000)
Saving in fixed selling	22000	(660000/12 X 2) X 20%
Total Saving in fixed cost	106000	(84000 + 22000)
4c
If plant is closed, the contribution lost is		316000	(as per 4a above)
What if the plant continues
Full Capacity for 2 months		20000	(as per 4a above)
25% capacity		5000
Contribution per unit		21.1	(as per 4a above)
Total Contribution		105500	(if plant continues)
If the plant continues, the company will earn $105,500 while if the plant is shut the lost contribution would be $316,000
Therefore it is better to continue plant at 25% capacity due to not enough saving in fixed cost
4d.
No they should continues at 25% capacity as per above examples
5. Calculation of avoidable cost
Total Units	120000
Variable cost per unit	26.9	(as per above)
Total variable Cost avoided	3228000
Reduction in fixed manf over	216000	(720000 X 30%)
Reduction in fixed selling exp	220000	(660000 minus 2/3rd of 660000)
Total cost avoided	2792000	(3228000 + 216000 + 220000)
Cost per unit avoided	23.26667	(2792000/ 120000)