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?

an increase in operating income of $ 40,000.

Explanation:

Consider the Savings and Costs that arise with the outsource decision.

Note : Fixed Costs are incurred whether or not outsource decision is made ( unavoidable) and are therefore irrelevant for this decision.

Savings :

Variable Costs ( 400,000 × $1.30)       520,000

Costs :

Purchase Price ( 400,000 × $1.20)     (480,000)

Effect : Net Income / (loss)                     40,000

If the Company decides to outsource there will be an increase in operating income of $ 40,000.

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