Question

Birch Company normally produces and sells 50,000 units of RG-6 each month. The selling price is $20 per unit, variable costs are $10 per unit, fixed manufacturing overhead costs total $190,000 per month, and fixed selling costs total $36,000 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 11,000 units per month. Birch Company estimates that the strikes will last for two months, after which time sales of RG-6 should return to normal. Due to the current low level of sales, Birch Company is thinking about closing down its own plant during the strike, which would reduce its fixed manufacturing overhead costs by $45,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $15,000. Because Birch Company uses Lean Production methods, no inventories are on hand Required: 1. What is the financial advantage (disadvantage) if Birch closes its own plant for two months? 2. Should Birch close the plant for two months? 3. At what level of unit sales for the two-month period would Birch Company be indifferent between closing the plant or keeping it open?

Answer 1

Answer -

Information given -

Birch Company normally produces and sells 50,000 units of RG-6 each month.

The selling price is $20 per unit, variable costs are $10 per unit, fixed manufacturing overhead costs total $190000 per month, and fixed selling costs total $36000 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 11000 units per month. Birch Company estimates that the strikes will last for two months, after which time sales of RG-6 should return to normal.

Due to the current low level of sales, Birch Company is thinking about closing down its own plant during the strike, which would reduce its fixed manufacturing overhead costs by $45000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $15000.

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Answer - Part - (1) - The Financial Disadvantage if Birch closes its own plant for two months -

# Working note - (1) - Calculation of Contribution per unit -

= Selling price per unit - Variable cost per unit

= $20 - $10

= $10 per unit.

# Working note - (2) - Calculation of Loss on Operation during strike period -

Particulars	Calculation	Amount in ( $ )
Sales	( 11000 units * 2 months * $20 )	440000
Less - Variable costs	( 11000 units * 2 months * $10 )	(220000)
Total Contribution	( $440000 - $220000 )	220000
Less - Fixed Manufacturing Overhead costs	( $190000 * 2 months )	(380000)
Less - Fixed Selling costs	( $36000 * 2 months )	(72000)
Net Income / (Loss)	( $220000 - $380000 - $72000 )	(232000)

# Working note - (3) - Calculation of Loss on Shutdown -

Particulars	Calculation	Amount in ( $ )
Unavoidable Fixed Manufacturing Overhead costs	[( $190000 - $45000 ) * 2 months ]	(290000)
Unavoidable Fixed Selling costs	[( $36000 - 10% ) * 2 months ]	(64800)
Additional Start-up Costs	Given in question	(15000)
Total Loss due to Shutdown		(369800)

Therefore,The Financial Disadvantage if Birch closes its own plant for two months =

= Loss on Shutdown - Loss on Operation during strike period

= ($369800) [ refer working note - (3) ] - ($232000) [ refer working note - (2) ]

= ($137800)

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Answer - Part - (2) -

No, Birch should not close the plant for two months, because there is financial disadvantage of ($1378000, if Birch closes its own plant for two month.

So, Birch should continue its operation during the two month period.

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Answer - Part - (3) -

Birch company would be indifferent between closing the plant or keeping it open if the sales units for the two-month period =

= {( saving in fixed cost on shutdown ) - ( start-up costs )} / contribution per unit

= { [ $45000 + ( 10% * $36000 )] * 2 months - ( $15000 )} / $10 per unit

= { ( $48600 * 2 months ) - $15000 } / $10 per unit

= $82200 / $10 per unit

= 8220 units.