Birch Company normally produces and sells 44.000 units of RG-5 cach month. RG-6

Question

Birch Company normally produces and sells 44.000 units of RG-5 cach month. RG-6 is a small electrical relay used as a component part in the automotive industry. The selling price is $26 per unit, variable costs are $15 per unit, fixed manufacturing overhead costs total $195,000 per month, and fixed selling costs total $40,000 per month. Employment contract stikes in the companies that purchase the bulk of the RG 6 units have caused airch Company's sales to temporanly drop to ony 11,000 units per month. Birch Company estimates that the strikes will last for two months, aner 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 hs own plant during the strike, which would reduce Its fked manufacturing overhead costs by $50,000 per month and its fixed selling costs by 9% Start-up costs at the end or the shutdown period would total $12.000. Because Birch Company uses Lean Production methods, no inventories are on hand. Required: a Assuming that the stnkes continue tor two months, what is the impact on income by closing the plant? decreased by n two months 1b. Would you recommend that Birch Company close its own plant? No O Yes 2 At what level of sales (in units) for the twa-month peniod should Birch Company be inditteren: between closing the plant or keeping it open? (Hint: This is a type of break even analysis, except that the nxed cost portion of yaur break even computation should include only those fixed costs rat are relevant e , avoidablel over the two-month period ) Round your firal answer to the nearest whole number.) sales it in two

Explanation / Answer

1a Net income is decreased by $146,800 in two months

Explanation:-
Product RG-6 yields a contribution margin of $11 per unit ($26 – $15 = $11). If the plant closes, this contribution margin will be lost on the 22,000 units (11,000 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:

Contribution margin lost by closing the plant for two months ($11 per unit × 22000units) $(242,000)
Costs avoided by closing the plant for two months:
Fixed manufacturing overhead cost $50,000
per month × 2 months = $100,000)              $1,00,000
Fixed selling costs
($40,000 per month × 9% ×2 months)             $7,200
$107,200
Net disadvantage of closing, before
                                   start-up costs                   ($134,800)
Add start-up costs                                                  12,000
Disadvantage of closing the plant                     ($146,800)

1b No

Explanation:-
No, the company should not close the plant; it should continue to operate at the reduced level of 11,000 units produced and sold each month. Closing will result in a $146,800 greater loss over thetwo-month period than if the company continues to operate. An additional factor is the potential loss of goodwill among the customers who need the 11,000 units of RG-6 each month. By closingdown, the needs of these customers will not be met (no inventories are on hand), and their business may be permanently lost to another supplier.

2. Birch Company will be indifferent at a level of 8655 total units sold over the two-month period.

Explanation :Cost avoided by closing the plant for two months(see above) $107,200
Less start-up costs                                                $12,000
Net avoidable cost                                                   $95,200

Net avoidable cost / per unit contribution margin
= $95,200/$11
= 8655 units

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