Lightning Semiconductors produces 400,000 hi-tech computer chips per month.Each chip uses a component that Lightning makes in-house.The variable costs to make the component are $1.30 per unit,and the fixed costs are $1,300,000 per month.The company has been approached by a foreign producer who can supply the component,within acceptable quality standards,for $1.20 each.The fixed costs are unavoidable,and Lightning would have no other use 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

If the company decides to outsource, the fixed costs remain the same, but the variable costs decrease from $1.30 to $1.20 per unit. Therefore, the cost savings per unit is $0.10. As the company produces 400,000 chips per month, the total cost savings would be:
$0.10 x 400,000 = $40,000 per month

Therefore, the company could save $40,000 per month by outsourcing the component. This would increase operating income by $40,000 compared to making the component in-house.

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