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Make or buy decision

From the estimated operational costs and revenues, Minnetonka Corporation should make the product and refrain from buying it, because it is more financially feasible. If the corporation makes the product, the contribution per pair of skis would amount to $10 per pair. While, the subcontractor option will yield a contribution per pair of skis of $9. 50. Contribution represents the excess of sales over the marginal cost of sales. In this respect through the former option, the company will attain a $0. 50 higher contribution per pair of skis over fixed costs than the subcontracting scheme.

Question 2 The maximum acceptable purchase price for Minnetonka Corporation from the subcontractor is $10 per pair. Through such a price the contribution per pair of skis of the buy option would coincide with that of the make option. Indeed such figure was determined by deducting the excess contribution of the make option over the subcontracting scheme to the price per pair of skis agreed with the subcontractor. Question 3 In case of the increase in sales of 2,500 pair of skis the buy decision becomes more financially viable than the make decision.

This is primarily due to the incremental rental fixed costs that are incurred

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under the make option, which diminish the contribution by a further $0. 80 per pair of skis to $9. 20 per pair of skis. In such a stance, the profit per pair of skis under the subcontracting scheme would be $0. 30 higher per pair of skis, since the contribution per pair of skis of the buy decision would remain the same at $9. 50 per pair of skis. Question 4 When evaluating a business decision management should not solely focus on the financial aspect of the business option.

Qualitative factors ought to be taken into account before reaching the final decision. As regards to the case at hand, Minnetonka Corporation should for instance consider the quality of the product supplied by the subcontractor. We have to bear in mind that price is not the only factor considered by clients in today’s business environment. Quality is another important facet, which may effect drastically the reputation of the company and market position. The reliability of the supplier is another critical aspect that ought to be considered.

Minnetonka Corporation should ensure that the subcontractor could supply enough quantity of stock at the right time. The loss in market share that may arise in shortage instances may significantly deteriorate the financial performance of the organization. Management should also deem the effect that the subcontracting option may pose on the present suppliers of direct materials of the company. A reduction in the materials ordered from the present suppliers may negatively affect the trading negotiations with such entities.

For example, certain trade and/or bulk discounts presently held may be lost. Further more, the importance of the company for the suppliers may diminish due to lower volumes ordered leading to less favorable credit terms, response quality and more.

References:

Brockington R. B. (1996). Financial Management. Sixth Edition. Essex: Progressive Printing (UK) Ltd. Drury C. (1996). Management and Cost Accounting. Fourth Edition. London: International Thomson Business Press. Hussey J. ; Hussey R. (1999). Cost and Management Accounting. Second Edition. New York: Palgrave.

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