Lightning Semiconductors produces 400,000 hi-tech computer chips per month.Each chip uses a component which Lightning 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

The variable cost of making the component in-house is $1.20 per unit, and the fixed costs are $1,200,000 per month. The company produces 400,000 chips per month, so the total cost of making the components in-house is $1.20 * 400,000 + $1,200,000 = $1,680,000.If the company outsources the components, it will pay $1.10 per unit for 400,000 units, which will cost $440,000. The fixed costs will be reduced by 40%, which will save the company $1,200,000 * 0.40 = $480,000.Therefore, the total cost of outsourcing the components will be $440,000 + $480,000 = $920,000. This is $1,680,000 - $920,000 = $760,000 less than the cost of making the components in-house.The operating income will increase by $760,000 if the company outsources the components.

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