Birch Company normally produces and sells 50,000 units of RG-6 each month. The s
ID: 2558357 • Letter: B
Question
Birch Company normally produces and sells 50,000 units of RG-6 each month. The selling price is $30 per unit, variable costs are $10 per unit, fixed manufacturing overhead costs total $180,000 per month, and fixed selling costs total $44,000 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 12,000 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 $42,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $14,000. 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?Explanation / Answer
Answer
Data is formulated for 2 months, considering alternatives if the production is not shut down and if its shut down.
If not closed/Shut down
If Shut down
based on 24000 units [12000 units each month]
2 month cost
Sales Revenue
$720000
0
Variable cost
$(240000)
0
Fixed manufacturing overhead
(360000)
(276000)
Fixed Selling Overhead
(88000)
(79200)
Start Up Cost
(14000)
Net Income (Loss)
$32,000
$(369,200)
Answer 1: If Company Shuts down for 2 months, it will be at a FINANCIAL DISADVANTAGE of $401,200
As the net income would be low by $401,200 if it shuts down production instead of continuing.
At Indifferent point, cost or net benefit under both alternative would be equal.
Let the units produced at Indifferent point be ‘x’
Then,
Net Benefit if not closed = Net Benefit if shut down
(30x - 10x)-360000-88000=-276000-79200-14000
20x - 448000 = - 369200
20x = 448000 - 369200
x = 78800 / 20
x = 3940 units
Hence, at 3940 units level, the company will be indifferent whether it continues or shuts down its plant.
If not closed/Shut down
If Shut down
based on 24000 units [12000 units each month]
2 month cost
Sales Revenue
$720000
0
Variable cost
$(240000)
0
Fixed manufacturing overhead
(360000)
(276000)
Fixed Selling Overhead
(88000)
(79200)
Start Up Cost
(14000)
Net Income (Loss)
$32,000
$(369,200)
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