g Birch Company normally produces and sells 48,000 units of RG-6 each month. The selling price is $26 per unit, variable costs are $17 per unit, fixed manufacturing overhead costs total $180,000 per month, and fixed selling costs total $40,000 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 9,000 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 $43,000 per month and its fixed selling costs by 11%. Start-up costs at the end of the shutdown period would total $13,000. 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:

Check the explanation

Explanation:

(1) Product RG-6 yields a contribution margin of $10 per unit ($20 - $10 = $10). If the plant closes, this contribution margin will be lost on the 18,000 units (9,000 units per month * 2 months) that could have been sold during the two-month period. However, the company will be able to avoid certain fixed costs as a result of closing down. The analysis is:

                                                                        Amount ($)           Amount ($)

Contribution margin lost by closing the

plant for two months ($10 * 18,000 units)                                   (180,000)

Costs avoided by closing the plant for two months:  

Fixed manufacturing overhead cost ($41,000 * 2 months)82,000  

Fixed selling costs ($48,000 * 10% * 2months)                   9,600 91,600

Net disadvantage of closing, before start-up cost                       (88,400)

Add start-up costs                                                                              13,000

Disadvantage of closing the plant                                                   101,400

(2) No, the company should not close the plant; it should continue to operate at the reduced level of 9,000 units produced and sold each month. Closing will result in a $101,400 greater loss over the two-month period than if the company continues to operate.

(3)

                                                                                              Amount ($)

Cost avoided by closing the plant for two months               91,600

Less: start-up costs                                                                  (13,000)

Net avoidable costs                                                                 78,600

Units = Net avoidable cost / Contribution margin per unit

= $78,600 / $10 = 7,860 units

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A. $180,000
B. $50,000
C. $150,000
D. $90,000
E. $120,000

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Old Backhoes New Backhoes
Purchase cost when new $90,000 $200,000
Salvage value now $42,000
Investment in major overhaul needed in next year $55,000
Salvage value in 8 years $15,000 $90,000
Remaining life 8 years 8 years
Net cash flow generated each year $30,425 $43,900
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