Doro Fill Company fabricates automobiles.Each auto includes one wiring harness,which is currently made in-house.Details of the harness fabrication are as follows:
$$\begin{array} { | l | r | l | }
\hline \text { Volume } & 800 & \text { units per month } \
\hline \text { Variable cost per unit } & \$ 7 & \text { per unit } \
\hline \text { Fixed costs } & \$ 15,000 & \text { per month } \
\hline
\end{array}$$ A factory in Indonesia has offered to supply Doro Fill with ready-made units for a cost of $10 each.Assume that Doro Fill's fixed costs are unavoidable and that the company will not be able to use the excess capacity in any profitable manner.In order to maximize operating income,Doro Fill should not outsource.

Question

Doro Fill Company fabricates automobiles.Each auto includes one wiring harness,which is currently made in-house.Details of the harness fabrication are as follows:
 $$\begin{array} { | l | r | l | } 
\hline \text { Volume } & 800 & \text { units per month } \
\hline \text { Variable cost per unit } & \$ 7 & \text { per unit } \
\hline \text { Fixed costs } & \$ 15,000 & \text { per month } \
\hline
\end{array}$$ A factory in Indonesia has offered to supply Doro Fill with ready-made units for a cost of $10 each.Assume that Doro Fill's fixed costs are unavoidable and that the company will not be able to use the excess capacity in any profitable manner.In order to maximize operating income,Doro Fill should not outsource.

Quizplus · Accepted Answer

The total cost of in-house production is $15,000 (fixed costs) + $7 * 800 (variable costs) = $21,600 for 800 units, which equals $27 per unit. Outsourcing would cost $10 per unit, totaling $8,000 for 800 units. The initial analysis mistakenly calculated the in-house cost per unit, not considering the fixed costs are sunk and unavoidable, leading to an incorrect comparison. Given the fixed costs are unavoidable and there's no profitable use for the freed capacity, the comparison should focus on variable costs and the outsourcing cost. Since the variable cost of $7 per unit is less than the $10 per unit to outsource, it's cheaper to continue producing in-house to minimize costs, assuming the fixed costs remain regardless of the decision.

Doro Fill Company Fabricates Automobiles A Factory in Indonesia Has Offered to Supply Doro Fill