Alexandria Semiconductors produces 400,000 hi-tech computer chips per month. Eac

Question

Alexandria Semiconductors produces 400,000 hi-tech computer chips per month. Each chip uses a component which Alexandria makes in house. The variable costs to make the component are $1.20 per unit, and the fixed costs run $1,200,000 per month.Alexandria has been approached by a foreign producer who can supply the component, ready made and with acceptable quality standards for $1.10 each. The fixed costs are unavoidable, and Alexandria would have no other use for the facilities currently employed in making the component. If Alexandria decides to outsource,it could reduce the fixed cost by 40%. What is the effect on operating income, if the company decides to outsource?

Explanation / Answer

Cost of manufacturing of component = $1.20 per unit

Cost of outsourcing component = $1.10 per unit

As the cost of outsourcing component is less than the manufacturing of component. So the components should be outsourced. it will increse the operating income by 400000* (1.20-1.10) = $40000.

As the fixed cost will remain same in both situations. So it is irrelevant for buy and make decision

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