Question

Problem 12-18 Relevant Cost Analysis in a variety of Situations (L012-2, L012-3, LO12-4) 16 points Andretti Company has a single product called a Dak. The company normally produces and sells 81,000 Doks each year at a selling price of $60 per unit. The company's unit costs at this level of activity are given below. eBook Direct materials Direct labor Variable manufacturing overhead Pixed manufacturing overhand Variable selling expenses Fixed welling expenses Total cost per unit $ 7.50 12.00 2.30 6.00 (9486,000 total) 4.50 ($364,500 total) $37.00 4.70 Print A number of questions relating to the production and sale of Daks follow. Each question is independent. References Required: 1-a. Assume that Andretti Company has sufficient capacity to produce 109,350 Daks each year without any Increase in fixed manufacturing overhead costs. The company could increase its unit sales by 35% above the present 81,000 units each year if it were willing to increase the fixed selling expenses by $140,000. What is the financial advantage (disadvantage) of investing an additional $140,000 in fixed selling expenses? 1-b. Would the additional investment be justified? 2. Assume again that Andretti Company has sufficient capacity to produce 109,350 Daks each year. A customer in a foreign market wants to purchase 28,350 Daks. If Andretti accepts this order it would have to pay Import duties on the Daks of $470 per unit and an additional $25,515 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 900 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 40% 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?

Answer 1

Answer to Question 1-a and 1-b:

Question 1-a Calculation of incremental net operating income Incremental units: 109,350 - 81,000 = 28,350 units Incremental Per unit Total Amount Calculation units Sales 28,350 $ 60.00 $ 1,701,000 (28,350 X 60.00) Variable costs: Direct materials 28,350 $ 7.50 $ 212,625 (28,350 X 7.50) Direct labor 28,350 $ 12.00 $ 340,200 (28,350 X 12.00) Variable manufacturing 28,350 $ 2.30$ 65,205 overhead (28,350 X 2.30) Variable selling expenses 28,350 $ 4.70 $ 133,245 (28,350 X 4.70) Total variable costs 28,350 $ 26.50 $ 751,275 (1,701,000 - Contribution margin $ 949,725 751,275) Incremental Fixed selling $ 140,000 3 expenses Incremental net (949,725 - $ 809,725 operating income 140,000) 5 Financial Advantage = $809,725 Question 1-b Since it results in incremental net operating income, the increase in fixed selling expenses is justified.

Answer to Question 2, 3 and 4-a:

Question 2 Calculate the break even price as follows: Sales - variable costs = Fixed costs (28,350 X sales price per unit) - (28,350 X (7.50 + 12.00 +2.30 +4.70 + 2.20)) = $25,515 28,350 X sales price per unit = 25,515 + 813,645 28,350 X sales price per unit = 839,160 Break even sales price per unit = $29.60 Therefore, the break even sales price is $29.60 per unit. Question 3 The cost incurred for manufacturing is a sunk cost as it already has been incurred hence it is not relevant. Fixed selling expenses are not relevant because they will be incurred whether the units are sold or not. The variable selling cost = $4.70 is the relevant cost Question 4-a Contribution per unit lost = Selling price per unit - Variable cost per unit Contribution per unit lost = 60.00 - 26.50 = $33.50 Units lost = (81,000/12) X 2 months X 75% = 10,125 We get 75%, since it mentions it will be operating at 25% for two months, hence that means we will be losing 75% of our units sold for 2 months Total Contribution lost = 10,125 X 33.50 = $339,187.50

Answer to Question 4-b, 4-c, and 4-d:

Question 4-b Total fixed manufacturing cost avoided = (486,000/12) X 2 months X 60% = 48,600 Total fixed selling cost avoided = (364,500/12) X 2 X 20% = 12,150 Total fixed costs avoided = 48,600 + 12,150 = $60,750 Question 4-c Decrease in sales (10,125 $ -607,500 X 60) Decrease in variable expenses $ 268,313 (10,125 X 26.50) Decrease in fixed costs $ 60,750 Impact on profits $ -278,438 (-607,500 + Calculation 268,313 + 60,750) Therefore, due to shutdown of plant, it will lead to reduction profit of $278,438 Financial disadvantage = $278,438 Question 4-d The Company should not shutdown the plant, it should continue operating at 25% for two months, because if it shuts down, it will lead to a reduction in profit amounting to $278,438 hence to avoid the reduction of the profit, it should continue operating the plant at 25% capacity.

Answer to Question 5:

Question 5 The relevant cost are those that can be avoided by purchasing from outside manufacturer. These costs are: Variable manufacturing costs per unit $ 21.80 ($7.50 + $12.00 + $2.30) Fixed Manufacturing cost 1.80 ($486,000 X 30% = $145,800/81,000) Variable selling expenses 1.57 ($4.70 X 1/3) Total costs avoided $ 25.17 $ $ $ The avoidable cost per unit = $25.17 The outsider manufacturer quotation must be less than $25.17 per unit, to be acceptable for the company.