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%.
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?
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%.
Direct Labor: $35 so ten percent is $ 3.50 from (10/100) x 35 = 3.5
Direct Material: $30 so twenty percent is $6
Total Overhead: $15 includes variable overhead and the fixed overhead of the $100,000 for the estimated 10,000 pair of skis as the expected volume. The fixed overhead per ski needs to be calculated. If we multiply $15 into the 10,000 skis we obtain the Total overhead for the expected volume of $150,000. The fixed overhead is $100,000. The difference is the variable overhead of $50,000. The variable overhead per ski is then $5 and the savings in this variable overhead is ten percent or fifty cents.
The total savings as postulated by the predicted reductions is then $10. This is less then the 10.50 purchase price for the bindings. In this scenario, Minnetonka Corporation should make its own bindings or find a better offer.
I am not sure about the profit ...
It is determined based on given data whether it is better to make or buy a component.