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 $58 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	7.50
Direct labor		10.00
Variable manufacturing overhead		2.00
Fixed manufacturing overhead		7.00	($595,000 total)
Variable selling expenses		3.70
Fixed selling expenses		3.50	($297,500 total)
Total cost per unit	$	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 106,250 Daks each year without any increase in fixed manufacturing overhead costs. The company could increase its unit sales by 25% above the present 85,000 units each year if it were willing to increase the fixed selling expenses by $100,000. What is the financial advantage (disadvantage) of investing an additional $100,000 in fixed selling expenses?

1-b. Would the additional investment be justified?

2. Assume again that Andretti Company has sufficient capacity to produce 106,250 Daks each year. A customer in a foreign market wants to purchase 21,250 Daks. If Andretti accepts this order it would have to pay import duties on the Daks of $4.70 per unit and an additional $12,750 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 600 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?

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 85,000 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

1a)

Selling price per unit		$       58.00
Less: Variable cost
Direct Materials	$   7.50
Direct Labor	$ 10.00
Variable Manufacturing Overhead	$   2.00
Variable selling expenses	$   3.70
		$       23.20
(a) Contribution per unit		$       34.80
(b) Additional units to be sold
(25% of 85000)		21250
Total Incremental contribution from in crease in sales		$ 7,39,500
(a x b)
Less: Increase in fixed selling expenses		$ 1,00,000
Incremental Income		$ 6,39,500

1b) As net contribution will increase by $6,39,500, the additional investment of $1,00,000 should be made in fixed selling expenses to effect 25% increase in sales.

2)

Variable cost for one unit of the export order
Direct Materials	$         7.50
Direct Labour	$       10.00
Variable Manufacturing Overhead	$         2.00
Import Duty	$         4.70
Shipping cost	$         2.20
(a) Total Variable cost per unit of export order	$       26.40
(b) Total units to be exported	21250
(c) Total variable cost associated with export (a x b)	$ 5,61,000
(d) Fixed cost specific to export order	$     12,750
(e) Total Contribution required to break even for the export order (c + d)	$ 5,73,750
Break even price per unit of export order (e / b)	$       27.00

Note:

The fixed manufacturing overhead and the fixed selling overhead is irrelevant because of the following reasons:

(a) The total number of units including the export order = 85000 + 21250 = 106250 and Fixed manufacturing overhead will remain same upto 106250 units

(b) Fixed selling overhead is not relevant for the units to be exported as the fixed selling overhead of $2,97,500 is related to the domestic sale

3) The unit cost price that is relevant for setting a minimum selling price for the 'seconds' is the variable cost of producing the units, i.e., $ 19.50

Direct Materials	$   7.50
Direct Labor	$ 10.00
Variable Manufacturing Overhead	$   2.00
Variable cost of producing one unit of Dak	$ 19.50

4)

a) Contribution foregone if the plant is closed for two months = $1,23,262

Working Notes:

Normal Level of production per year = 85000 units

production at 25% of normal level for two months = 85000 x 25% x (2/12) = 3542 units

Total contribution from 3542 units = 3542 x $34.80 = $1,23,262 (to nearest dollar)

b) Total fixed cost that could be avoided if the plant is closed down for 2 months = $69417

It has been assumed that sales, fixed manufacturing overhead and fixed selling overhead have been incurred uniformly over the year

Working Notes:

Saving in cost if the plant is shut down for two months
Savings in Fixed Manufacturing Overhead	$     59,500
(100% - 40%) x $5,95,000 x (2/12)
Savings in fixed selling overhead (to nearest dollar)	$       9,917
20% x $2,97,500 x (2/12)
Total incremental savings if Plant is shut down	$     69,417

c) Financial disadvantage of closing the plant for two month period

= Contribution forgone - Avoidable fixed cost

= $1,23,262 - $69,417 = $53,845

There will be a loss of contribution by $53,845 over and above the savings in fixed costs if the plant is closed down for 2 months

d) Based on the above analysis the plant should not be closed down for two months