Problem 12-26 Shutting Down or Continuing to Operate a Plant [LO2]

(Note: This type of decision is similar to dropping a product line.) Nicholas Company manufactures a fast-bonding glue, normally producing and selling 76,000 litres of the glue each month. This glue, which is known as MJ-7, is used in the wood industry to manufacture plywood. The selling price of MJ-7 is $65 per litre, variable costs are $39 per litre, fixed manufacturing overhead costs in the plant total $437,000 per month, and the fixed selling costs total $585,200 per month.

Strikes in the mills that purchase the bulk of the MJ-7 glue have caused Nicholas Companys sales to temporarily drop to only 19,000 litres per month. Nicholas Companys management estimates that the strikes will last for two months, after which sales of MJ-7 should return to normal. Due to the current low level of sales, Nicholas Companys management is thinking about closing down the plant during the strike.

If Nicholas Company does close down the plant, fixed manufacturing overhead costs can be reduced by $114,000 per month and fixed selling costs can be reduced by 10%. Start-up costs at the end of the shutdown period would total $20,040. Since Nicholas Company uses lean production methods, no inventories are on hand.

Required: 1-a. Assuming that the strikes continue for two months, compute the increase or decrease in income from closing the plant.

1-b. Would you recommend that Nicholas Company close its own plant?

multiple choice

• No

• Yes

2. At what level of sales (in litres) for the two-month period should Nicholas Company be indifferent between closing the plant and 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.)