Solution
Andretti Company
Assumptions –
Increase in unit sales by 30% from 121,000 units to reach 157,300 units
Fixed manufacturing overheads remain same
Selling administrative overheads increase $130,000
Calculation of contribution margin –
Contribution margin = unit sales price – unit variable cost
Unit sales price =$50
Unit variable cost –
Direct materials $9.50
Direct labor $10.00
Variable manufacturing overhead $2.90
Variable selling overhead $3.70
Total $26.10
Contribution margin = $50 - $26.10 = $23.90
Determination of additional net income from sale of additional units –
Additional units = 36,300 (121,000 x 30%)
Additional contribution = $23.90 x 36,300 = $867,570
Additional selling expenses $130,000
Additional income $737,570
Hence, the financial advantage of investing an additional $130,000 in fixed selling expenses to produce and sell additional 30% units (36,300) each year is increase in net income by $737,570.
1-b. Since the company has enough capacity to produce 157,300 Daks the increase in production and sales by 30% allows the company to fully absorb the fixed manufacturing overhead and selling and administration overhead.
Hence, the company is justified to make the additional investment of $130,000 to produce additional 30% units of Daks.
Given information –
Number of units 36,300
Additional variable cost –
Import duty $3.70
So, revised variable cost per unit –
Direct material $9.50
Direct labor $10.00
VMOH $2.90
Selling OH $2.00
Import duty $3.70
Total variable cost per unit $28.10
Additional fixed cost for permits and licenses $29,040
Break-even price per unit for the order,
At break-even, total revenues = total costs
Let the break-even price per unit be $x,
Revenues = $36,300x
Total costs = ($ 28.10 x 36,300) + $29,040
= $1,020,030 + $29,040 = $1,049,070
Hence, $36,300 x = $1,049,070
So, x = 1,049,070/36,300 = $28.90 per unit
The break-even price per unit for the special order is $28.90
The relevant unit cost is the variable selling price - $3.70
Since the 500 Daks are already produced, the variable production costs are sunk costs and no more relevant.
The fixed costs are also sunk costs.
Since the 500 Daks are not to be sold through regular channels, the relevant unit cost figure for the determination of the minimum selling price is the variable selling expenses - $3.70
4.a Determination of the amount of contribution margin that Andretti has to forego if it closes the plant for two months:
when plant is closed for two months, the contribution margin for the two months production is lost.
Two months production = 121,000 x 2/12 = 20,167 units
25% production in two months = 20,167 x25% = 5,042 units
Contribution lost when plant is closed for two months = 5,042 x $23.90 = $120,504
Contribution Margin lost if the plant is closed for two months = $120,504
4.b. Determination of the fixed cost, which the company would avoid if the plant is closed for two months:
Since the company would incur 30% of fixed manufacturing cost, despite closing down of the plant,
The fixed manufacturing cost, the company would avoid is 70% - 70% of ($363,000 x 2/12) =$42,350
The fixed selling and administrative costs reduced by 20% = 20% of ($665,500 x2/12) =$22,183
Total fixed costs the company would avoid by closing the plant for two months = $42,350 + $22,183 = $64,533
Total avoidable fixed cost = $64,533
4.c financial advantage or disadvantage of closing the plant for two months –
Contribution margin lost if plant is closed = 23.90 x 5,042 units = $120,504
Contribution foregone = ($120,504)
Fixed costs avoided = $64,533
Disadvantage of closing the plant = excess contribution lost over avoidable fixed cost
= ($55,971)
4d. assuming the company operates the plant for two months –
25% production for two-month period-
Annual normal production = 121,000 units
Monthly production = 121,000/12 = 10,083 units
Two months normal production = 2 x 10,083 = 20,167 units
25% production for two months = 20,167 x 25% = 5,042 units
Contribution from 25% production = $23.90 x 5,042 units =$120,504
Total fixed cost –
Fixed manufacturing overhead $363,000 x 2/12 = $60,500
Fixed selling overhead $665,500 x 2/12 = $110,917
Total fixed costs for two months = 60,500 + 110,917 = $171,417
Net profit/(Loss) ($50,913)
Comparison of the net loss from continuing production with the net disadvantage of closing the plant for two months,
= ($55,971) – ($50,913) = ($5,058)
Since the relative loss on closing the plant is higher compared to continuing production for 2 months at 25% volume results in net loss of $5,058 the recommendation is to continue production for two months.
No, Andretti should not close the plant for two months.
5a Determination of Andretti’s avoidable cost per unit that it should compare to the price quoted by the outside manufacturer:
Number of units offered to produce 121,000
Avoidable variable costs –
Direct materials cost $9.50
Direct labor cost $10.00
Variable MOH $2.90
Variable S&A OH $1.23 ($3.70 x 1/3)
Total $23.63
Total avoidable variable cost $23.63
Add: Avoidable fixed cost (30% of $363,000)/121,000 =$0.90
Total avoidable cost = $23.63 + $0.90 = $24.53
Avoidable cost per unit =$24.53
Hence, Andretti should accept a price that is less than the $24.53 per Dak from an outside manufacturer.
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