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. If the company chooses to outsource, it could reduce the fixed costs by 40%. The company does not have any 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

If Lightening Semiconductors chooses to outsource, it would save $0.10 per unit ($1.20 variable cost - $1.10 outsourcing cost).

Current total variable costs = $1.20 x 400,000 = $480,000
Total variable costs with outsourcing = $1.10 x 400,000 = $440,000
Total fixed costs with outsourcing = $1,200,000 x 0.6 = $720,000

Current operating income = (Revenue - Total variable costs - Total fixed costs) = (Revenue - $480,000 - $1,200,000) = Revenue - $1,680,000
New operating income with outsourcing = (Revenue - Total variable costs with outsourcing - Total fixed costs with outsourcing) = (Revenue - $440,000 - $720,000) = Revenue - $1,160,000

To find the effect on operating income, we need to compare the current operating income with the new operating income:

Revenue - $1,680,000 = Revenue - $1,160,000 + $520,000
$520,000 = $520,000

Therefore, operating income would go up by $520,000 if Lightening Semiconductors chooses to outsource.

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