Question

Andretti Company has a single product called a Dak. The company normally produces and sells 83,000 Daks each year at a selling price of $64 per unit. The company’s unit costs at this level of activity are given below:

Direct materials	$	8.50
Direct labor		10.00
Variable manufacturing overhead		3.20
Fixed manufacturing overhead		7.00	($581,000 total)
Variable selling expenses		2.70
Fixed selling expenses		4.00	($332,000 total)
Total cost per unit	$	35.40

4. Due to a strike in its supplier’s plant, Andretti Company is unable to purchase more material for the production of Daks. The strike is expected to last for two months. Andretti Company has enough material on hand to operate at 25% of normal levels for the two-month period. As an alternative, Andretti could close its plant down entirely for the two months. If the plant were closed, fixed manufacturing overhead costs would continue at 35% of their normal level during the two-month period and the fixed selling expenses would be reduced by 20% during the two-month period.

a. How much total contribution margin will Andretti forgo if it closes the plant for two months?

b. How much total fixed cost will the company avoid if it closes the plant for two months?

c. What is the financial advantage (disadvantage) of closing the plant for the two-month period?

d. Should Andretti close the plant for two months?

Answer 1

a. Contribution margin per unit = Selling price per unit - Direct materials per unit - Direct labor per unit - Variable manufacturing overhead per unit - Variable selling expenses per unit

= $64 - $8.5 - $10 - $3.2 - $2.7

= $39.6

b. Avoidable fixed costs = 65% of fixed manufacturing overhead + 20% of fixed selling expenses

= ($581,000 * 65%) + ($332,000 * 20%)

= $444,050

c. Financial advantage = Avoidable fixed costs - Contribution margin lost

= $444,050 - (83,000 * $39.6 * 25%)

= ($377,650)

d. No (as there is financial disadvantage)