Question

Birch Company normally produces and sells 44.000 units of RG-6 each month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is dollar 25 per unit, variable costs are dollar 21 per unit fixed manufacturing overhead costs total dollar 185,000 per month, and fixed selling costs total dollar 34,000 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 13.000 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 dollar 60,000 per month and its fixed selling costs by 11%. Start-up costs at the end of the shutdown period would total dollar 14,000. Because Birch Company uses Lean Production methods, no inventories are on hand. Required: Assuming that the strikes continue for two months, what is the impact on income by closing the plant? Would you recommend that Birch Company close its own plant? Yes No At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant or keeping it open?

Answer 1

Qn no 1a.

Situation	Normal Situation	Production Continues during Strike	Plant Shut Down
Sales unit	44000	13000	0
unit Sale price	$             25.00	$         25.00	$             25.00
Unit Variable Cost	$             21.00	$         21.00	$             21.00
Contribution per unit	$              4.00	$           4.00	$               4.00
Total Contribution	$     176,000.00	$   52,000.00	$                  -
Fixed Cost	$     219,000.00	$ 219,000.00	$     155,260.00
Profit	$     (43,000.00)	$(167,000.00)	$    (155,260.00)
Profit during 2 months	$     (86,000.00)	$(334,000.00)	$    (310,520.00)
Start up Cost			$       14,000.00
Actual Profit during 2 months	$     (86,000.00)	$(334,000.00)	$    (324,520.00)

So Net Income decresed by 324520 - 86000 = $238,520 in two months

1b.

If plant is not shut down and sales only 13000 units of RG-6 per month, Profit will be reduced by only (334000 - 86000)

= $ 248000, so Britch company should shut down the plant.

Answer : Yes

2.

If Plant is shut down:

Cost Saving Fixed Cost =( 60000+34000*11% ) * 2 - 14000 =$ 113480 during 2 months

Contribution of $113480 has to be earned from sale of 113480/4 = 28370 units during 2 months or 14185 units per month.

So Level of sales = 28370 units in two months