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The Minnetonka Corporation, which produces and sells to wholesalers a highly successful line of water skis, has decided to diversify to stabilize sales throughout the year. The company is considering the production of cross-country skis.
After considerable research, a cross-country ski line has been developed. Because of the conservative nature of the company management, however, Minnetonka's president has decided to introduce only one type of the new skis for this coming winter. If the product is a success, further expansion in future years will be initiated.
The ski selected is a mass-market ski with a special binding. It will be sold to wholesalers for $80 per pair. Because of availability capacity, no additional fixed charges will be incurred to produce the skis. A $100,000 fixed charge will be absorbed by the skis, however, to allocate a fair share of the company's present fixed costs to the new product.
Using the estimated sales and production of 10,000 pair of skis as the expected volume, the accounting department has developed the following cost per pair of skis and bindings:
Direct Labor: $35
Direct Material: $30
Total Overhead: $15
Total: $80
Minnetonka has approached a subcontractor to discuss the possibility of purchasing the bindings. The purchase price of the bindings from the subcontractor would be $5.25 per binding, or $10.50 per pair. If the Minnetonka Corporation accepts the purchase proposal, it is predicted that direct-labor and variable-overhead costs would be reduced by 10% and direct-material costs would be reduced by 20%.
1. Should the Minnetonka Corporation make or buy the bindings? Show calculations to support your answer.
2. What would be the maximum purchase price acceptable to the Minnetonka Corporation for the bindings? Support your answer with an appropriate explanation.
3. Instead of sales of 10,000 pair of skis, revised estimates show sales volume at 12,500 pair. At this new volume, additional equipment, at an annual rental of $10,000 must be acquired to manufacture the bindings. This incremental cost would be the only additional fixed cost required even if sales increased to 30,000 pair. (This 30,000 level is the goal for the third year of production.) Under these circumstances, should the Minnetonka Corporation make or buy the bindings? Show calculations to support your answer.
4. What nonquantifiable factors should the Minnetonka Corporation consider in determining whether they should make or buy the bindings?
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1. Should the Minnetonka Corporation make or buy the bindings? Show
calculations to support your answer.
We already know that if the bindings are made in-house, the cost to
produce each pair of skis will be $80. We must now determine whether
it would cost less to produce the skis if bindings were purchased from
an outside supplier. The resulting changes to the production cost are
as follows.
purchase price:
Buying two bindings for each pair of skis causes a change of +$10.50.
direct labor:
10% of the current direct-labor cost of $35 is
0.10 * $35 = $3.50,
contributing a change of -$3.50.
direct material:
20% of the current direct-material cost is
0.20 * $30 = $6,
contributing a change of -$6.00.
overhead:
We know that the total overhead for each pair of skis is $15, but this
includes the fixed charge of $100,000 for the 10,000 pairs. The fixed
charge amounts to
$100,000 / 10,000 = $10
per pair of skis. We are told that there are no additional fixed charges,
so the remainder of the overhead consists of variable charges. Thus,
the variable overhead for each pair of skis is
$15 - $10 = $5.
Given a reduction in variable overhead of 10%, the resulting change is
0.10 * $5 = $0.50.
Adding up all the changes, we see that the production cost of each pair
of skis becomes
$80 + $10.50 - $3.50 - $6.00 - ...
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