Question

Sanchez Semiconductors produces​ 200,000 high-tech computer chips per month. Each chip uses a component that Sanchez makes​ in-house. The variable costs to make the component are​ $1.40 per​ unit, and the fixed costs are​ $1,100,000 per month. The company has been approached by a foreign producer who can supply the​ component, within acceptable quality​ standards, for​ $1.10 each. If the company chooses to​ outsource, fixed costs can be reduced by​ 30%. There are no other uses for the facilities currently employed in making the component. What would be the effect on operating​ income, if the company decides to​ outsource?

A.

There would be no effect on operating income.

B.

Operating income would increase by​ $390,000.

C.

Operating income would increase by​ $220,000.

D.

Operating income would decrease by​ $60,000.

Answer 1

Total cost to make = ($1.40 X 200,000) + $1,100,000 = $1,380,000

Only 30% of the fixed cost can be avoided, remaining 70% is unavoidable.

Total cost to outsource = ($1.10 X 200,000) + ($1,100,000 X 70%) = $990,000

Cost of outsource is less than cost to make. There will be a increase in operating income if the units are outsourced.

Increase in operating income = $1,380,000 - $990,000 = $390,000

Option b.