The Watson Corporation, which produces and sells to wholesalers a highly successful line of water skis, has decided to diversify to stabilise sales throughout the year. The company is considering the production of cross-country skis.
After considerable research, a cross-country ski has been developed. Because of the conservative nature of the company management, however, Watson's CEO 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 RM80 per pair. Because of available capacity, no additional fixed charges will be incurred to produce the skis. A RM125,000 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 costs per pair of skis and bindings:
RM
Direct labour 35
Direct materials 30
Total overhead 15
Total cost 80
Watson has approached a subcontractor to discuss the possibility of purchasing the binding. The purchase price of the bindings from the subcontractor would be RM5.25 per binding, or $10.50 per pair. If the Watson Corporation accepts the purchase proposal, it is predicted that direct labour and variable overhead costs would be reduced by 10% and direct materials cost would be reduced by 20%.
1. Should the Watson Corporation make or buy the bindings? Show calculations to support your answer.
2. What would be the maximum purchase price acceptable to Watson Corporation for the bindings? Support your answer with an appropriate explanation.
3. Instead of sales of 10,000 pairs of skis, revised estimates show sales volume at 12,500 pairs. At this new volume, additional equipment, at an annual rental of RM10,00, 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 pairs. (The 30,000 level is the goal for the 3rd year of production.) Under these circumstances, should the Watson Corporation make or buy the bindings? Show calculations to support your answer.
4. The company has the option of making and buying at the same time. What would be your answer to No.3 if this alternative were considered? Show calculations to support your answer.
5. What non-quantifiable factors should Watson consider in determining whether they should make or buy the bindings?