Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 55

Closing a Plant

You have been asked to assist the management of Ironwood Corporation in arriving at certain decisions. Ironwood has its home office in Michigan and leases factory buildings in Wisconsin, Minnesota, and North Dakota, all of which produce the same product. Ironwood’s management provided you a projection of operations for next year as follows:

	Total	Wisconsin	Minnesota	North Dakota
Sales revenue	$880000	$440000	$280,000	$160,000
Fixed costs
Factory	220,000	112,000	56,000	52,000
Administration	70,000	42,000	22,000	6,000
Variable costs	290,000	133,000	85,000	72,000
Allocated home office costs	100,000	45,000	35,000	20,000
Total	$680,000	$332,000	$198,000	$150,000
Operating profit	$200,000	$108,000	$ 82,000	$ 10,000

The sales price per unit is $5.

Due to the marginal results of operations of the factory in North Dakota, Ironwood has decided to cease its operations and sell that factory’s machinery and equipment by the end of this year. Ironwood expects that the proceeds from the sale of these assets would equal all termination costs. Ironwood, however, would like to continue serving most of its customers in that area if it is economically feasible and is considering one of the following three alternatives:

•         Expand the operations of the Minnesota factory by using space presently idle. This move would result in the following changes in that factory’s operations:

Increase over Minnesota factory’s current operations
Sales revenue	50%
Fixed costs
Factory	20
Administration	10

Under this proposal, variable costs would be $2 per unit sold.

•         Enter into a long-term contract with a competitor who will serve that area’s customers. This competitor would pay Ironwood a royalty of $1 per unit based on an estimate of 30,000 units being sold.

•         Close the North Dakota factory and not expand the operations of the Minnesota factory. Total home office costs of $100,000 will remain the same under each situation.

Required

To assist the management of Ironwood Corporation, prepare a schedule computing Ironwood’s estimated operating profit from each of the following options:

a. Expansion of the Minnesota factory.

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b. Negotiation of long-term contract on a royalty basis.

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c. Shutdown of North Dakota operations with no expansion at other locations.

Step 1 of 4

In a regular process of making profitable business decisions managers often considers whether to drop or a product line or close a business unit or factory. Few product lines may be profitable earlier but may lose its business because of the new product line of a competitor. In this situation, management may decide to drop the unprofitable product line.