Birch Company normally produces and sells 41,000 units of RG-6 each month. RG-6

Question

Birch Company normally produces and sells 41,000 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 $27 per unit, variable costs are $20 per unit, fixed manufacturing overhead costs total $170,000 per month, and fixed selling costs total $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 14,000 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 $60,000 per month and its fixed selling costs by 9%. Start-up costs at the end of the shutdown period would total $16,000. Because Birch Company uses Lean Production methods, no inventories are on hand.

Required: 1a. Assuming that the strikes continue for two months, what is the impact on income by closing the plant?

1b. Would you recommend that Birch Company close its own plant?

2. 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?

Explanation / Answer

Birch Company Situation: Production continues fro two months Details Per unit Total Per Month Total For two Months Units sold         14,000                    28,000 Sales Revenue @27 per unit                27      378,000                  756,000 Variable cost @20 per unit                20      280,000                  560,000 Contribution                  7         98,000                  196,000 Fixed Manufacturing Overhead      170,000                  340,000 Fixed selling Overhead         34,000                    68,000 Total Fixed Costs      204,000                  408,000 Net Operating Income    (106,000)               (212,000) 1.a. Birch Company Situation: Plant Closed down. Details Per unit Total Per Month Total For two Months Units sold Sales Revenue @27 per unit                             -   Variable cost @20 per unit                             -   Contribution                             -   Fixed Manufacturing Overhead      110,000                  220,000 Fixed selling Overhead         30,940                    61,880 Total Fixed Costs      140,940                  281,880 Add : Starting up cost                    16,000 Net Operating Income    (140,940)               (297,880) So by Closing Plant net loss in two month will increase by                               =297800-212000= $ 85,880 1.b. The point of indifference between closing the plant and continuing production happens when net loss in production in two months is equal to $297880 Details Per unit Total Per Month Total For two Months Required net loss                  297,880 Add Fixed costs                  408,000 Required contribution                  110,120 Contribution         55,060                  110,120 Contribution /unit                   7 Required units/ month           7,866                    15,731 The point of indifference between closing the plant and continuing production is at monthly production level of 7866 units for two months or 15731 units in two months.

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