Valuable Electronics uses a standard part in the manufacture of different types of radios manufactured by it. The total cost of producing 25,000 parts is $95,000, which includes fixed costs of $40,000 and variable costs of $55,000. The company can buy the part from an outside supplier for $3 per unit, and avoid 20% of the fixed costs. If Valuable Electronics decides to outsource the production of the part, how will it impact its operating income?

Question

Quizplus · Accepted Answer

Currently, the cost of producing 25,000 parts internally is:

Total Cost = Fixed Cost + Variable Cost
Total Cost = $40,000 + ($55,000/25,000) * 25,000
Total Cost = $95,000

If the company outsources the production of the part, the total cost would be:

Total Cost = (Cost per Unit x Number of Units) + Reduced Fixed Cost
Total Cost = ($3 x 25,000) + ($40,000 x 0.8)
Total Cost = $95,000

Therefore, outsourcing the production of the part would not impact the company's operating income, but it would reduce the fixed costs by 20%. The company would pay the same amount for the total cost while avoiding the fixed costs. Thus, the operating income would decrease by $12,000 (which is the amount of the fixed costs avoided).

Valuable Electronics Uses a Standard Part in the Manufacture of Different