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
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%.
Excel file contains solution of relevant costing problem.