The Minnetonka Corporation, which produces and sells towholesalers a highly successful line of water skis, has decided todiversify to stabilize sales throughout the year. The company isconsidering the production of cross-country skis.
After considerable research, a cross-country ski line has beendeveloped. Because of the conservative nature of the companymanagement, however, Minnetonka's president has decided tointroduce only one type of the new skis for this coming winter. Ifthe product is a success, further expansion in future years will beinitiated.
The ski selected is a mass-market ski with a special binding. Itwill be sold to wholesalers for $80 per pair. Because ofavailability capacity, no additional fixed charges will be incurredto produce the skis. A $100,000 fixed charge will be absorbed bythe skis, however, to allocate a fair share of the company'spresent fixed costs to the new product.
Using the estimated sales and production of 10,000 pair of skisas the expected volume, the accounting department has developed thefollowing 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 thepossibility of purchasing the bindings. The purchase price of thebindings from the subcontractor would be $5.25 per binding, or$10.50 per pair. If the Minnetonka Corporation accepts the purchaseproposal, it is predicted that direct-labor and variable-overheadcosts would be reduced by 10% and direct-material costs would bereduced 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 theMinnetonka Corporation for the bindings? Support your answer withan appropriate explanation.
3. Instead of sales of 10,000 pair of skis, revised estimates showsales volume at 12,500 pair. At this new volume, additionalequipment, at an annual rental of $10,000 must be acquired tomanufacture the bindings. This incremental cost would be the onlyadditional fixed cost required even if sales increased to 30,000pair. (This 30,000 level is the goal for the third year ofproduction.) Under these circumstances, should the MinnetonkaCorporation make or buy the bindings? Show calculations to supportyour answer.
4. The company has the option of making and buying at the sametime. What would be your answer to number 3 if thisalternative were considered? Show calculations to supportyour answer.
5. What nonquantifiable factors should the Minnetonka Corporationconsider in determining whether they should make or buy thebindings?