Aircraft Products, a manufacturer of aircraft landing gear, makes 1,000 units ea

Question

Aircraft Products, a manufacturer of aircraft landing gear, makes 1,000 units each year of a special valve used in assembling one of its products. The unit cost of producing this valve includes variable costs of $70 and fixed costs of $60. The valves could be purchased from an outside supplier at $77 each. If the valve were purchased from the outside supplier, 40% of the total fixed costs incurred in producing this valve could be eliminated. Buying the valves from the outside supplier instead of making them would cause the company's operating income to:

Explanation / Answer

All the given information is needed.
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Scenario 1 (In-house production):

To produce 1,000 units, variable costs are ( 1,000 x $70 ) = $70,000
To produce 1,000 units,fixed costsare ( 1,000 x $60 ) = $60,000

Total cost in this scenario = ( $70,000 + $60,000 ) = $130,000
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Scenario 2 (Buy from outside vendor):

Purchase cost of 1,000 units = ( 1,000 x $77 ) = $77,000

Save 40% on fixed costs implies that fixed costs in this scenario are 60% of what they were in the 'In-house' scenario. [ 1.00 - 0.40 = 0.60 ]

Fixed costs in this scenario are ( $60,000 x 0.60 ) = $36,000

Total costs (outside vendor scenario) = ( $77,000 + $36,000 ) = $113,000
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The 'outside vendor' scenario total costs are ($130,000 - $113,000 ) = $17,000 less than the 'In-house' scenario total costs.

So, by choosing the 'outside vendor' option, operating income would increase by $17,000

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