P7-20 Shutting Down or Continuing to Operate a Plant – Hallas Company
P7-20 Hallas Company manufactures fast-bonding glue in its Northwest plant. The company normally produces and sells 40,000 gallons 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 $35 per gallon, variable costs are $21 per gallon, fixed manufacturing overhead costs in the plant total $230,000 per month, and the fixed selling costs total $310,000 per month.
Strikes in the mills that purchase the bulk of the MJ-7 glue have caused Hallas Company’s sales to temporarily drop to only 11,000 gallons per month. Hallas Company’s management estimates that the strike will last for two months, after which sales of MJ-7 should return to normal. Due to the current low level of sales, Hallas Company’s management is thinking about closing down the Northwest plant during the strike.
If Hallas Company does close down the Northwest plant, fixed manufacturing overhead costs can be reduced by $60,000 per month and fixed selling costs can be reduced by 10%. Start-up costs at the end of the shutdown period would total $14,000. Because Hallas Company uses lean production methods, no inventories are on hand.
1. Assuming that the strikes continue for two months, would you recommend that Hallas Company close the Northwest plant? Explain. Show computations to support your answer.
2. At what level of sales (in gallons) for the two-month period should Hallas Company be indifferent between closing the plant or keeping it open? Show computations.
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.