Question

Birch Company normally produces and sells 47,000 units of RG-6 each month. The selling price is $24 per unit, variable costs are $17 per unit, fixed manufacturing overhead costs total $150,000 per month, and fixed selling costs total $40,000 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 $48,000 per month and its fixed selling costs by 11%. Start-up costs at the end of the shutdown period would total $15,000. 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?

Answer 1

1. The financial advantage (disadvantage) if Birch closes its own plant for two months :-

Particulars	Amount	Working
Loss of Sales	576,000	12,000*2*$24
Start up cost after close down	15,000
Total loss (A)	591,000
Savings
Variable cost	408,000	12,000*2*$17
Fixed manufacturing costs	96,000	48,000*2
Fixed Selling costs	8,800	40,000*2*11%
Total savings (B)	512,800
Financial disadvantage (A) - (B)	$78,200

2. No, as there is financial disadvantage of $78,200 so he should not close down the plant.

3. At break even point,

Total loss = Total savings

Let units sold be 'x'

$24*2*x + 15,000 = $17*2*x + 96,000 +8,800

48x + 15,000 = 34x + 104,800

14x = 89,800

x = 6,414.28 units

or

x = 6,415 units