a. Based on the given information, it is advisable for the management to shut down the plant. Here are the reasons:
1. Current Capacity Level: The company is operating at only 50% capacity level, manufacturing 2,000 carpets per year. This indicates that there is excess production capacity that is not being utilized efficiently.
2. Labour Crisis: The company is facing a labour crisis, which is likely affecting productivity and the ability to meet customer demands. Operating under such conditions can lead to compromised quality and customer dissatisfaction.
3. Financial Impact: By shutting down the plant, the company can reduce fixed manufacturing overheads from ₹20,00,000 to ₹10,00,000 and fixed administrative overheads from ₹15,00,000 to ₹5,00,000. This will help reduce costs and preserve financial resources during the labor crisis.
4. Recovery Period: The management is certain that the labor problem will be resolved and business will recover after a few months. Therefore, it makes more financial sense to temporarily shut down the plant, minimize costs, and resume operations when the labor crisis is resolved.
b. In case the plant was operating at 80% capacity level instead of 50%, the decision might change. Let's calculate the costs:
Current capacity: 2,000 carpets per year
At 80% capacity level: 80% of 2,000 = 1,600 carpets per year
Total variable cost per carpet:
Direct material: ₹5,000
Direct labor: ₹2,000
Variable overhead: ₹1,000
Total variable cost per carpet = ₹5,000 + ₹2,000 + ₹1,000 = ₹8,000
Total fixed costs:
Manufacturing overhead (current): ₹20,00,000
Administrative overhead (current): ₹15,00,000
Total fixed costs (current) = ₹20,00,000 + ₹15,00,000 = ₹35,00,000
Total fixed costs (if plant shuts down) = ₹10,00,000 + ₹5,00,000 = ₹15,00,000
To decide whether to shut down or continue operating at 80% capacity, compare the costs:
Cost of operating at 80% capacity:
Fixed costs + (Variable cost per carpet x Number of carpets)
Cost of operating at 80% capacity = ₹35,00,000 + (₹8,000 x 1,600)
Cost of shutting down the plant = ₹15,00,000 + ₹10,00,000 (additional labor cost)
Compare the two costs and assess which option is more financially viable for the company.