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
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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Question 1 – 30 30
Question 2 – 20 20
Question 3 – 25 25
Question 4 – 25 25
Instructions for IP 3
This problem is a make or buy decision problem which can be tricky. You must read this problem carefully, especially concerning the overhead. If you miss this part of the problem, all of your answers will be affected.
1. Provide calculations and make a decision about whether to make or buy the bindings that go on the skis. This can be done in a couple of ways.
a. You can compute the total reductions that will occur if you don’t make the bindings and compare that to the cost of buying the bindings. (Preferred method since this will help in question 2.)
b. You can compute the total cost of making the skis with purchased bindings, taking into account the reductions and the cost of buying the bindings.
2. What is the total you would be willing to pay to an outside source for the bindings? This is based on the amount of reductions found in question 1.
3. Provide calculations and make a decision about whether to make or buy the bindings if you increase production to 12,500 units or 30,000 units.
a. Remember that the original fixed costs that you computed in problem 1 are not relevant in this decision, i.e. we don’t consider them. The new fixed costs are relevant.
4. Provide an explanation of what other factors should be considered. These factors will be qualitative factors, not quantitative. In other words, we have considered the cost of the question, but there are other things that will affect our decision.
ANSWERS (deliverable 1-2 pgs)
1) labor @ $35/pr x 10,000 prs = $350,000
material @ $30/pr x 10, 000prs = $300,000
overhead @ $15/pr x 10,000prs = $150,000
total cost $800.000
ten percent labor/ 350,000 x .10 = $35,000
ten percent overhead/ 150,000 x .10 = $15,000
twenty percent materials/ 300,000 x.20 = $60,000
Total savings $110,000
Bindings @ $10.50/pr x 10,000prs = $105,000
Net savings $5,000
Based on the small percentage that would be saved $.50/pr they should make the bindings.
2)$ 7.50/pr This would save $35,000/ $3.50/pr.
3) First year cost for additional equipment would be $1/pr 10,000/10,000 by year three the additional cost per pair would fall to $.33/pr while sales have tripled. They should invest in the equipment and make the binders.
4) If Minnetonka makes the binders they have direct influence and control over the vendors they deal with, quality of materials, workmanship etc. This eliminates the possibility of sub-contractors who cannot deliver on time and /or deliver inferior goods. By making the binders Minnetonka has more direct control over the quality and cost of the binders and stregthens their ability to meet production goals.
This in-depth solution works through a Minnetonka Case Study to determine the value of making or buying bindings, maximum purchase price, and qualitative factors.