The Minnetonka Corporation, which produces and sells towholesalers a highly succ
ID: 2433446 • Letter: T
Question
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%.
Explanation / Answer
1) MakeSkis& MakeSkis&Bindings BuyBindings Costof making Saleprice $80 $80.00 Bindings ------ ----------------- ----------------- Directmaterials $30 $30x80% = $24.00 $6.00 Directlabor $35 $35x90% = $31.50 $3.50 Varableoverhead $5 $5 x90% = $4.50 $0.50 $10.00 Cost per pair of making binding ($10.00) is less thancost of buying ($10.50), so making is recommended. 2) maximum purchase price for bindingsshould equal to cost of making in house i.e.$10.00. If binding is purchased at $10.00 then therewill be no effect on its contribution i.e. ($80 - $24 - $31.50 - $5 - $10 ) =$10 as cost of making in-house will also fetch the same contributionmargin per pair i.e ($80 - $30 - $35 - $5) = $10. 3) cost of bindings for 10,000pairs $10.00per pair Rent for producing 12,500pairs ($10,000 /12,500) $0.80per pair Totalcost of makingbindings $10.80per pair Since cost of making ($10.80) is more than cost of buying($10.80), buying is recommended option. 4) Same since cost of making is higher than cost ofbuying. 5) Quality of bindings. delivery period if purchasedfrom outside. Reliability of subcontactor andagreement atleast for 3 years period. Cost per pair of making binding ($10.00) is less thancost of buying ($10.50), so making is recommended. 2) maximum purchase price for bindingsshould equal to cost of making in house i.e.$10.00. If binding is purchased at $10.00 then therewill be no effect on its contribution i.e. ($80 - $24 - $31.50 - $5 - $10 ) =$10 as cost of making in-house will also fetch the same contributionmargin per pair i.e ($80 - $30 - $35 - $5) = $10. 3) cost of bindings for 10,000pairs $10.00per pair Rent for producing 12,500pairs ($10,000 /12,500) $0.80per pair Totalcost of makingbindings $10.80per pair Since cost of making ($10.80) is more than cost of buying($10.80), buying is recommended option. 4) Same since cost of making is higher than cost ofbuying. 5) Quality of bindings. delivery period if purchasedfrom outside. Reliability of subcontactor andagreement atleast for 3 years period.