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Case 7-29 (continued)
Because the contribution margin per unit of the constrained resource (i.e., welding time) is larger for the
mountain bike frames than for the XSX drums, the frames make the most profitable use of the welding
machine. Consequently, the company should manufacture as many mountain bike frames as possible up
Case 7-29 (continued)
Solution assuming direct labor is a variable cost
(a)
(b)
(c)
(a) × (c)
(a) × (b)
Quantity
Unit
Contri-
bution
Margin
Welding
Time
per Unit
Total
Welding
Time
Balance
of
Welding
Time
Total
Contri-
bution
Total hours available ....................
2,000
XSX Drums—make ......................
2,500
$103.10
0.80
2,000
0
$257,750
Mountain bike frames produced ...
0
24.00
0.20
0
0
0
XSX Drums—buy .........................
500
33.15
16,575
Total contribution margin .............
274,325
Less: Contribution margin from
present operations: 2,500
drums × $103.10 CM per drum .
257,750
Increased contribution margin
and net operating income .........
$ 16,575
Case 7-30 (continued)
Depreciation is not relevant to the decision because it is a sunk cost.
Moreover, whether the plant is closed or continues to operate, all of
the remaining book value of the equipment and buildings will
eventually be written off. A total of $700,000 of the annual pension
fixed costs incurred outside the Greenville Cover Plant that
presumably would not change if the plant were closed.
c. The following nonrecurring costs would arise in the year that the
plant is closed, but would not be incurred in any other year:
Termination charges on canceled material orders
($8,000,000 × 25%) ............................................
$2,000,000
Employment assistance ...........................................
800,000
Total nonrecurring costs ..........................................
$2,800,000
These two costs are relevant to the decision because they will be
incurred only if the plant is closed. The $2,000,000 salvage value of
the equipment and buildings offsets these costs.
3. No, the plant should not be closed. The computations are:
First Year
Other Years
Cost of purchasing the covers outside ...
$(21,000,000)
$(21,000,000)
Annual costs avoided by closing the
plant (Part 2a) ...................................
17,900,000
17,900,000
Cost of closing the plant (first year non-
recurring costs) .................................
(2,800,000)
Salvage value of buildings and
equipment .........................................
2,000,000
Net advantage (disadvantage) of closing
the plant ...........................................
$ (3,900,000)
$ (3,100,000)
