Lightening Semiconductors produces 400,000 hi-tech computer chips per month. Each chip uses a component which Lightening makes in-house. The variable costs to make the component are $1.20 per unit, and the fixed costs run $1,200,000 per month. The company has been approached by a foreign producer who can supply the component, ready-made and with acceptable quality standards for $1.10 each. The fixed costs are unavoidable, and Lightening would have no other use for the facilities currently employed in making the component. What is the effect on operating income, if the company decides to outsource?

Question

Quizplus · Accepted Answer

The variable cost per unit to make the component in-house is $1.20, while the cost to purchase it from the foreign producer is $1.10. This means that Lightening Semiconductors would save $0.10 per unit on variable costs if they choose to outsource. 
If the company produces 400,000 chips per month, this translates to a monthly cost savings of $40,000 ($0.10 x 400,000). 
Since the fixed costs of $1,200,000 per month are unavoidable, there will be no change in this cost whether the component is made in-house or purchased from the foreign producer. 
Therefore, the company's operating income would increase by $40,000 per month if they choose to outsource the component.

Lightening Semiconductors Produces 400,000 Hi-Tech Computer Chips Per Month