Lightening Semiconductors produces 200,000 hi-tech computer chips per month.Each chip uses a component which Lightening makes in-house.The variable costs to make the component are $1.20 per unit and the fixed costs run $1,100,000 per month.The company has been approached by a foreign producer who can supply the component,ready-made and with acceptable quality standards for $1.20 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 profit if the company decides to outsource?

Question

Quizplus · Accepted Answer

If the company outsources the component, it would save 40% of the fixed cost, which is $440,000 (40% of $1,100,000). The variable cost of outsourcing is the same as in-house production - $1.20 per unit. Therefore, the total cost of production is the same. However, by outsourcing, the company saves $440,000 in fixed costs. This would increase the operating profit by $440,000.

Lightening Semiconductors Produces 200,000 Hi-Tech Computer Chips Per Month