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Birch Company normally produces and sells 30,000 units of RG-6 each month. The selling price is $22 per unit, variable costs are $14 per unit, fixed manufacturing overhead costs total $150,000 per month, and fixed selling costs total $30,000 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 8,000 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 $45,000 per month and its fixed selling costs by 10%. Start-up costs at the end of the shutdown period would total $8,000. Because Birch Company uses Lean Production methods, no inventories are on hand.

What is the financial advantage (disadvantage) if Birch closes its own plant for two months?
At what level of unit sales for the two-month period would Birch Company be indifferent between closing the plant or keeping it open? (Hint: This is a type of break-even analysis, except that the fixed cost portion of your break-even computation should include only those fixed costs that are relevant (i.e., avoidable) over the two-month period.)

2 Answers

5 votes

Final answer:

1) Closing the plant for two months would result in a financial advantage of $256,000 for Birch Company.

2) There is no level of unit sales at which Birch Company would be indifferent between closing the plant and keeping it open.

Explanation:

To determine the financial advantage or disadvantage of closing the plant for two months, we need to compare the costs and revenues for both scenarios: keeping the plant open and closing the plant.

1. Keeping the Plant Open:

- Sales per month: 30,000 units

- Selling price per unit: $22

- Variable cost per unit: $14

- Fixed manufacturing overhead costs per month: $150,000

- Fixed selling costs per month: $30,000

Total revenue per month: 30,000 units $22 = $660,000

Total variable costs per month: 30,000 units $14 = $420,000

Total fixed costs per month: $150,000 + $30,000 = $180,000

Profit per month:

Total revenue - Total variable costs - Total fixed costs

= $660,000 - $420,000 - $180,000

= $60,000

Total profit for two months: $60,000 2 = $120,000

2. Closing the Plant:

- Sales per month: 8,000 units

- Selling price per unit: $22

- Variable cost per unit: $14

- Reduced fixed manufacturing overhead costs per month: $150,000 - $45,000 = $105,000 (as the strike reduces the fixed costs)

- Reduced fixed selling costs per month: $30,000 - 10% of $30,000 = $27,000 (as the strike reduces the fixed costs)

Total revenue per month: 8,000 units $22 = $176,000

Total variable costs per month: 8,000 units $14 = $112,000

Total fixed costs per month: $105,000 + $27,000 = $132,000

Profit per month:

Total revenue - Total variable costs - Total fixed costs

= $176,000 - $112,000 - $132,000

= -$68,000 (a loss of $68,000 per month)

Total loss for two months: -$68,000 * 2 = -$136,000

3. Financial Advantage (Disadvantage) of Closing the Plant:

The financial advantage (disadvantage) of closing the plant for two months is the difference between the profit if the plant remains open and the loss if the plant is closed.

Financial advantage (disadvantage) = Profit (Keeping Plant Open) - Loss (Closing Plant)

= $120,000 - (-$136,000)

= $120,000 + $136,000

= $256,000

Therefore, if Birch Company closes its own plant for two months, it would have a financial advantage of $256,000.

4. Unit Sales for Indifference:

To determine the level of unit sales for the two-month period at which Birch Company would be indifferent between closing the plant and keeping it open, we need to find the point where the profit from keeping the plant open equals the loss from closing the plant.

Profit (Keeping Plant Open) = Loss (Closing Plant)

$60,000 2 = -$68,000 2

$120,000 = -$136,000

Since the profit cannot equal the loss, there is no level of unit sales at which Birch Company would be indifferent between closing the plant and keeping it open.

In summary, closing the plant for two months would result in a financial advantage of $256,000 for Birch Company. However, there is no level of unit sales at which Birch Company would be indifferent between closing the plant and keeping it open.

2 votes

Final answer:

1) Closing the plant for two months would result in a financial advantage of $256,000 for Birch Company.

2) There is no level of unit sales at which Birch Company would be indifferent between closing the plant and keeping it open.

Step-by-step explanation:

To determine the financial advantage or disadvantage of closing the plant for two months, we need to compare the costs and revenues for both scenarios: keeping the plant open and closing the plant.

1. Keeping the Plant Open:

- Sales per month: 30,000 units

- Selling price per unit: $22

- Variable cost per unit: $14

- Fixed manufacturing overhead costs per month: $150,000

- Fixed selling costs per month: $30,000

  • Total revenue per month: 30,000 units * $22 = $660,000
  • Total variable costs per month: 30,000 units * $14 = $420,000
  • Total fixed costs per month: $150,000 + $30,000 = $180,000

Profit per month:

Total revenue - Total variable costs - Total fixed costs

= $660,000 - $420,000 - $180,000

= $60,000

Total profit for two months: $60,000 * 2 = $120,000

2. Closing the Plant:

- Sales per month: 8,000 units

- Selling price per unit: $22

- Variable cost per unit: $14

- Reduced fixed manufacturing overhead costs per month: $150,000 - $45,000 = $105,000 (as the strike reduces the fixed costs)

- Reduced fixed selling costs per month: $30,000 - 10% of $30,000 = $27,000 (as the strike reduces the fixed costs)

  • Total revenue per month: 8,000 units * $22 = $176,000
  • Total variable costs per month: 8,000 units * $14 = $112,000
  • Total fixed costs per month: $105,000 + $27,000 = $132,000

Profit per month:

Total revenue - Total variable costs - Total fixed costs

= $176,000 - $112,000 - $132,000

= -$68,000 (a loss of $68,000 per month)

Total loss for two months: -$68,000 * 2 = -$136,000

3. Financial Advantage (Disadvantage) of Closing the Plant:

The financial advantage (disadvantage) of closing the plant for two months is the difference between the profit if the plant remains open and the loss if the plant is closed.

Financial advantage (disadvantage) = Profit (Keeping Plant Open) - Loss (Closing Plant)

= $120,000 - (-$136,000)

= $120,000 + $136,000

= $256,000

Therefore, if Birch Company closes its own plant for two months, it would have a financial advantage of $256,000.

4. Unit Sales for Indifference:

To determine the level of unit sales for the two-month period at which Birch Company would be indifferent between closing the plant and keeping it open, we need to find the point where the profit from keeping the plant open equals the loss from closing the plant.

Profit (Keeping Plant Open) = Loss (Closing Plant)

$60,000 * 2 = -$68,000 * 2

$120,000 = -$136,000

Since the profit cannot equal the loss, there is no level of unit sales at which Birch Company would be indifferent between closing the plant and keeping it open.

In summary, closing the plant for two months would result in a financial advantage of $256,000 for Birch Company. However, there is no level of unit sales at which Birch Company would be indifferent between closing the plant and keeping it open.

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