Sanchez Semiconductors produces 200,000 high-tech computer chips per month.Each chip uses a component that Sanchez makes in-house.The variable costs to make the component are $1.40 per unit,and the fixed costs are $1,100,000 per month.The company has been approached by a foreign producer who can supply the component,within acceptable quality standards,for $1.10 each.If the company chooses to outsource,fixed costs can be reduced by 30%.There are no other uses for the facilities currently employed in making the component.What would be the effect on operating income,if the company decides to outsource?

Question

Quizplus · Accepted Answer

Currently, the variable costs of producing 200,000 chips per month are:
Variable costs = 200,000 x $1.40 = $280,000
Fixed costs = $1,100,000
Total costs = $1,380,000

If the company chooses to outsource, the variable costs would decrease by $0.30 per unit:
New variable costs = 200,000 x $1.10 = $220,000
Fixed costs would decrease by 30%:
New fixed costs = $1,100,000 x 0.7 = $770,000
Total costs would be:
Total costs = $220,000 + $770,000 = $990,000

Operating income would be:
Operating income = Revenue - Total costs
Revenue remains the same at 200,000 chips x $10 per chip = $2,000,000
Operating income = $2,000,000 - $990,000 = $1,010,000

The effect on operating income is an increase of $1,010,000 - $1,380,000 = $370,000.
Therefore, the correct answer is B) Operating income would increase by $390,000.

Sanchez Semiconductors Produces 200,000 High-Tech Computer Chips Per Month