Cheong Automobile Company fabricates automobiles. Each vehicle includes one water pump, which is currently made in-house. Details of the water pump assembly are as follows: $$\begin{array} { | l | r | l | }
\hline \text { Volume } & 1200 & \text { units per month } \
\hline \text { Variable cost per unit } & \$ 11.50 & \text { per unit } \
\hline \text { Fixed costs } & \$ 10,000 & \text { per month } \
\hline
\end{array}$$ An Indonesian factory has offered to supply Cheong Automobile Company with ready-made units for a cost of $16 for each water pump. Assume that Cheong's fixed costs are unavoidable and that Cheong will not be able to use the excess capacity in any profitable manner. If Cheong decides to outsource, monthly operating income will ________.

Question

Cheong Automobile Company fabricates automobiles. Each vehicle includes one water pump, which is currently made in-house. Details of the water pump assembly are as follows: $$\begin{array} { | l | r | l | } 
\hline \text { Volume } & 1200 & \text { units per month } \
\hline \text { Variable cost per unit } & \$ 11.50 & \text { per unit } \
\hline \text { Fixed costs } & \$ 10,000 & \text { per month } \
\hline
\end{array}$$ An Indonesian factory has offered to supply Cheong Automobile Company with ready-made units for a cost of $16 for each water pump. Assume that Cheong's fixed costs are unavoidable and that Cheong will not be able to use the excess capacity in any profitable manner. If Cheong decides to outsource, monthly operating income will ________.

Quizplus · Accepted Answer

The current total cost of producing 1200 units in-house is the sum of variable costs and fixed costs: $1200 \times \$11.50 + \$10,000 = \$23,800$. If Cheong outsources, the cost for 1200 units will be $1200 \times \$16 = \$19,200$. The difference in costs is $ \$23,800 - \$19,200 = \$4,600$, not \$5,400. However, since the fixed costs of \$10,000 are unavoidable and cannot be eliminated by outsourcing, they do not affect the comparison between in-house production and outsourcing. Therefore, the correct calculation should only consider the variable costs and the cost of outsourcing. The error in the explanation indicates a mistake in the calculation or the interpretation of the fixed costs' role in the decision. The correct approach is to compare the total current cost of in-house production (including unavoidable fixed costs) to the total cost of outsourcing. Since the initial explanation provided an incorrect calculation, let's correct the analysis:Current total cost of in-house production: $1200 \times \$11.50 + \$10,000 = \$23,800$.Cost of outsourcing: $1200 \times \$16 = \$19,200$.The difference, therefore, is $ \$23,800 - \$19,200 = \$4,600$, which suggests savings, not an increase or decrease by \$5,400 as previously stated. The mistake was in the calculation of the savings and misunderstanding the role of fixed costs in this scenario. Given the provided options and the correction in understanding, none of the options directly match the corrected calculation. The initial response was based on a misunderstanding. The correct analysis should focus on comparing the total costs directly, but given the options and the mistake in the initial calculation, a reevaluation of the decision's impact on monthly operating income is necessary, focusing on the correct interpretation of fixed and variable costs and the actual savings or cost difference.

Cheong Automobile Company Fabricates Automobiles An Indonesian Factory Has Offered to Supply Cheong Automobile Company