Problem 9-8 Deciding Whether to Shut Down or Continue to Operate a Plant (LO1 -

Question

Problem 9-8 Deciding Whether to Shut Down or Continue to Operate a Plant (LO1 - CC3) Birch Company normally produces and sells 31,500 units of RG-6 each month. RG-6 is a small electrical relay used in the automotive industry as a component part in various products. The selling price is $25 per unit, variable costs are $17 per unit, fixed manufacturing overhead costs total $157,500 per month, and fixed selling costs total $31,500 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 11,000 units per month. Birch Company estimates that the strikes will last for about two months, after which time sales of RG-6 should return to normal. Due to the current low level of sales, however, Birch Company is thinking about closing its own plant during the two months that the strikes are on. If Birch Company does close its plant, it is estimated that fixed manufacturing overhead costs can be reduced to $110,250 per month and that fixed selling costs can be reduced by 10%. Startup costs at the end of the shutdown period would total $11,000. Since Birch Company uses just-in-time production methods, no inventories are on hand Required 1-a. Assuming that the strikes continue for two months, compute the increase or decrease in income from closing the plant. in income 1-b.Would you recommend that Birch Company close its own plant? Yes No 2. At what level of sales (in units) for the two-month period should Birch Company be indifferent between closing the plant and keeping it open? Level of sales units

Explanation / Answer

SOLUTION

1A. Comparative analysis to continue or shut down a plant-

Net loss will increase by $37,600 per month plus start up cost $11,000. hence the total will increase by $86,200.

1B. 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.

2.

Level of sales - Net avoidable costs / Per unit contribution margin

= $89,800 / $8 = 11,225 units

Continue ($) Shut Down ($) Difference ($) Sales (11,000*$25) 275,000 0 (275,000) Variable costs (11,000*$17) 187,000 0 187,000 Contribution margin 88,000 0 (88,000) Fixed costs: Manufacturing costs 157,500 110,250 47,250 Selling costs 31,500 28,350 3,150 Total fixed costs 189,000 138,600 50,400 Net Operating loss (101,000) 138,600 37,600

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