Activity Based Costing

The Minnetonka Corp., 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 mangemennt, 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 experience 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 availabiliy 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.

Isomg tje esto,ated sa;es amd [rpdictopm pf 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: $15M

Minnetonka has approached a subcontractor to discuss the possibility of purchasing the bindings. The purchase of price of the bindings from the subcontractor would be $5.25 per binding, or $10.50 per pair. If the Minnetonka Corp. 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 corp make or buy the bindings? Show answer with an appropriate explantion.

2. What would be the maximum purchase price acceptable to the Minnetonka corp for the bindings? Support 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 corp make or buy the bindings? Show calculaions to support the answer.

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