Sierra semiconductors produces 200 comma 000 highminustech computer chips per month. each chip uses a component that sierra makes inminushouse. the variable costs to make the component are $ 1.40 per unit, and the fixed costs are $ 1 comma 300 comma 000 per month. the company has been approached by a foreign producer who can supply the component, within acceptable quality standards, for $ 1.00 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?

Operating income will increase by $470,000 in case the production of component is outsourced.

Explanation:

Provided information we have,

Number of high-tech computer chips produced during a month = 200,000

Component required to make that product,

Details of component,

Variable cost = $1.40 per unit,

Cost for 200,000 units = 200,000 $1.40 = $280,000

Fixed cost = $1,300,000

Total cost of producing = $1,580,000

In case of buying option, we have,

Buying cost = $1 per unit = $1 200,000 = $200,000

Also add: unavoidable fixed cost = $1,300,000 70% = $910,000

Total cost of buying = $1,110,000

Benefit in case of buying = Cost of manufacturing - Cost of buying = $1,580,000 - $1,110,000 = $470,000

Thus, in case company outsources such production then there will be increase in operating income by $470,000 as cost will be reduced by such amount.