3 Activity Based Costing

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.

• Minnetonka should buy the bindings as it costs less per pair to buy them ($79.50) rather than to make them ($80.00):

make Discount Calculation buy

Direct Labor $ 35.00 -10% $35 - ($35 * .1) $ 31.50

Direct material $ 30.00 -20% $30 - ($30 * .2) $ 24.00

Overhead $ 15.00 -10% $15 - ($15 * .1) $ 13.50

subtotal $ 69.00

+ bindings $ 10.50

Total $ 80.00 $ 79.50

2. What would be the maximum purchase price acceptable to the Minnetonka Corporation for the bindings? Support your answer with an appropriate explanation.

• Perfectly competitive companies maximize profits by producing the quantity where the cost is less than or equal to the revenue generated. In this case, each pair costs $69 to buy. The optimal cost for the bindings should not exceed the price per pair ($80.00). Therefore, the maximum allowable price for the bindings should not exceed $80.00 (sale price) - $69.00 (bought manufacturing) = $11.00

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