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    Cost volume profit (CVP) analysis for Minnetonka Corporation

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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 qualitative factors (i.e. issues with vendors, customers, or within the product itself) should the Minnetonka Corporation consider in determining whether they should make or buy the bindings?

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    Solution Preview

    Please see the attached file for complte solution and calculations. Thanks

    Selling Price $80 per pair
    Fixed costs allocated $100,000
    Quantity 10,000 pair
    Fixecd charge $10.00 per pair
    Labor cost $35 per pair
    Direct Material $30 per pair
    Total Overhead $15 per pair
    Total Cost $80 per pair

    Variable Overhead cost $5 per pair

    Part 1
    The incremental change in costs if bindings are bought from subcontractor
    Cost of buying a pair of binding $10.50 per pair
    Total cost of buying decision $105,000.00

    Savings from buy decision
    Decrease in direct labor $3.50 ...

    Solution Summary

    This problem illustrates how to approach a typical make or buy decision. We calculate the cost per unit under the make situation and under the buy situation. The important concepts for solving this problem is identifying the relevant costs for the two decisions. For additional sales, the relevant costs are incremental costs. By solving this problem, one will be able to understand the financial implications of make or buy decisions. The posting ends with discussing the qualitative factors which one should consider along with the financial figures while taking these decisions.