Question

Andretti Company has a single product called a Dak. The company normally produces and sells 85,000 Daks each year at a selling price of $62 per unit. The company's unit costs at this level of activity are given below: $ 7.50 12.00 3.00 Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Variable selling expenses Fixed selling expenses Total cost per unit 4.00 ($340,000 total) 3.70 3.50 ($297,500 total) $33.70 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 119,000 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 40% above the present 85,000 units each year if it were willing to increase the fixed selling expenses by $120,000. What is the financial advantage (disadvantage) of investing an additional $120,000 in fixed selling expenses? 1-b. Would the additional investment be justified? 2. Assume again that Andretti Company has sufficient capacity to produce 119,000 Daks each year. A customer in a foreign market wants to purchase 34,000 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $2.70 per unit and an additional $30,600 for permits and licenses. The only selling costs that would be associated with the order would be $2.70 per unit shipping cost. What is the break-even price per unit on this order? 3. The company has 500 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 fiqure 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 35% 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?

Answer 1

For Andretti Company

As the given scenarios deal with taking decisions, we could make use of Marginal Costing technique, as it is one of the well used cost management techniques for Decision making by Managerial Personnel.

WN-1: Contribution per unit=Sales price per unit-Variable Cost per unit=$62-$(7.5+12+3+3.7)=$62-$26.2=$35.8

Case 1:

(a)When the unit sales incerase by 40% and Fixed selling Overheads increase by $120000

Particulars	At Present	Changes	Proposed Change
1.Sales Volume(in units)	85000	Increase by 40%	119000
2.Sales Price p.u(in $)	62	-	62
3.Variable Cost p.u(in $) (fromWN-1)	26.2	-	26.2
4.Contribution per unit(2-3)	35.8	-	35.8
5.Total Contribution(1*4)	3043000	-	4260200
6.Total Fixed Cost	637500	Increase by $120000	757500
7.Total Profit(5-6)	2405500		3502700
8.Incremental Profit/(Loss)			1097200

(b) As from the above it is clear that by undertaking an additional cost of $120000, it was able to generate an additional profit of $1097200, which says that the incremental costs are less than incremental revenues, the decision of the management to incur an additional fixed selling costs of $120000, over and above its present situation is justified.

Case 2:

When additional 34000units produced to export them,

Varibale cost per unit in such circumstances will be

=Direct Material+Direct Labor+Variable Manufactured Overheads+Duty payable+Shipping cost.

=$(7.5+12+3+2.7+2.7)

=$27.9**

Total Additional Fixed Cost =$30600

Total Additional Fixed Cost per unit =$30600/34000units=$0.9 per unit

Break Even Price per unit***=Variable Cost per unit+Additional Fixed Cost per unit*=$27.9+$0.9=$28.8

*As the prior 85000 units have already realized fixed costs and the additional units produced are much within in the total capacity of the entity, the present fixed cost would be irrelevant for pricing decision in the given case, besides only additional fixed cost would be relevant for pricing decision here as it has been incurred soley for the purpose of this case.

**Selling Overheads will not part of Variable cost, as those expenses are not incurred in other than domestic sales scenario in the given case,and expenses like shipping cost and duty paid will form part of variable cost per unit in given case as they are directly associated with the product.

***Break Even Price is that price where the company does not earn any profit or suffer any loss.

Case 3

When having irregularity with regard to 500 daks

In case of irregularities, the product will not be able to fetch the general sale price, it had to be modified to be able to be sold to the customers.

The minimum price at which it has to be sold in such kind of situations, should be such that the entity has to atleast recover the variable cost incurred on such units.

So Minimum Sales for 500 daks would be =500 daks*$26.2=$$13100

Case 4

When the factory is closed for 2 months time due to strikes

WN-2

If the entity does not shut the factory for 2 months

(1)Number of units that could be produced and sold in the given case =[(85000/12m)*2m]*25%=3542units

(2)Total Contribution from 3542 units =3542*$35.8=$126803.6

(3)Total fixed cost for 2 months (from (b)(3) Total)=$106250

(4)Net benefit if the entity does not shut the factory for 2 months(2-3)=$20533.6

Total Fixed Cost for 2 months

Particulars	If not closed	If Closed	Difference	Total
1.Manufacturing Overheads	$56667	$56667*35% =$19833	$36834	$(340000/12)*2m =$56667
2.Selling Overheads	$49583	$49583*80% =$39667	$9916	$(297500/12)*2m =$49583
3.Total	$106250	$59500	$46750	$106250

(a) If the plant shuts for 2m the entity has to forego $126803.6 total contribution by selling 3542 units(from WN-2)

Contribution margin=Contribution/Sales=35.8/62=57.7419% approx

(b)If the plant shuts for 2m it could avoid fixed cost of $46750(from WN-2)

(c)The Finacial (Disadvantage)/Advantage for closing the business.

Net benefit if the factory is not shut =$20533.6

Benefit/(Loss) if the factory is shut=$(126803.6)*+$46750=($80053.6)

*It is an imputed cost and is crucial for decision making in the given case,As the entity losses the opportunity to earn a contribution of $126803.6

(d)It is beneficial to the entity if it does not shut the factory and continue to run for that 2 months on bases of results of (c).

Case 5

When considering to purchase from outside

Particulars	After Proposed Change(2)	Present(1)	Difference(3=1-2)
1.Fixed Manufacturing Overheads	$340000*70%=$238000	$400000	$162000
2.Variable Selling Expenses	$3.7*85000u*2/3rd=$209667	$314500	$104833
3.Total	$447667	$714500	$266833

If the company purchases from outside it would be able to avoid a total cost of $266833, which it needs to consider to find out the feasible rate at which the purchase could be made from the outside vendor.