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?
1. To determine whether Minnetonka Corporation should make or buy the bindings, we need to compare the costs of making with the costs of buying.
The current cost per pair of skis and bindings if produced internally is as follows:
Direct Labor: $35
Direct Material: $30
Total Overhead: $15
Total: $80
If Minnetonka Corporation decides to buy the bindings from the subcontractor, the cost per pair of skis and bindings would be as follows:
Direct Labor (reduced by 10%): $31.50
Direct Material (reduced by 20%): $24
Total Overhead: $15
Binding cost: $10.50
Therefore, the total cost per pair of skis and bindings if purchased would be $81.
Since the cost of producing internally is lower at $80 per pair compared to $81 per pair if purchased, Minnetonka Corporation should MAKE the bindings.
2. To determine the maximum acceptable purchase price for the bindings, we need to find the price at which the cost of making and buying are equal.
Let "x" be the purchase price per binding. Since two bindings are required per pair of skis, the purchase price per pair would be 2x.
The cost per pair of skis and bindings if purchased would be $81.
For making the bindings, the cost per pair of skis and bindings is $80, with the binding cost being $10.50.
Equating the costs:
2x + $81 = $80 + $10.50
Simplifying the equation:
2x = $10.50 - $1
2x = $8.50
x = $4.25
Therefore, the maximum purchase price acceptable to the Minnetonka Corporation for the bindings would be $4.25 per binding, or $8.50 per pair.
3. If the sales volume increases to 12,500 pairs of skis, additional equipment costing $10,000 per year must be acquired to manufacture the bindings. However, this incremental cost would be the only additional fixed cost required, even if sales increased to 30,000 pairs.
To determine whether Minnetonka Corporation should make or buy the bindings at the new sales volume, we need to compare the costs with and without the additional fixed cost.
If Minnetonka Corporation continues to make the bindings, the cost per pair of skis and bindings would remain the same as before: $80.
If Minnetonka Corporation decides to buy the bindings, the cost per pair of skis and bindings would be as follows:
Direct Labor (reduced by 10%): $31.50
Direct Material (reduced by 20%): $24
Total Overhead: $15
Binding cost: $10.50
Therefore, the total cost per pair of skis and bindings if purchased would be $81.
Since the cost of producing internally is still lower at $80 per pair compared to $81 per pair if purchased, Minnetonka Corporation should CONTINUE to make the bindings.
4. In determining whether to make or buy the bindings, Minnetonka Corporation should consider the following qualitative factors:
- Quality Control: If the bindings purchased from the subcontractor do not meet the quality standards, it can lead to customer dissatisfaction and potential product recalls. Minnetonka Corporation needs to assess the subcontractor's quality control processes and reputation.
- Supply Chain Reliability: Minnetonka Corporation should evaluate the reliability of the subcontractor's supply chain. Any disruptions or delays in the delivery of the bindings can impact the production and delivery schedules of the skis.
- Vendor Relationships: If Minnetonka Corporation has established strong and trusted relationships with its current suppliers, it may prefer to continue making the bindings internally to maintain those relationships.
- Cost Variability: Minnetonka Corporation should assess whether the cost of purchasing the bindings is stable or subject to fluctuations. If the purchase price is volatile, it can affect profit margins and make forecasting more challenging.
- Strategic Focus: Minnetonka Corporation needs to consider its long-term strategic goals. If the company aims to integrate vertically or expand its manufacturing capabilities, it may be more inclined to continue making the bindings internally.
By considering these qualitative factors, Minnetonka Corporation can make an informed decision regarding whether to make or buy the bindings.