Aircraft Products, a manufacturer of aircraft landing gear, makes 1,100 units ea

Question

Aircraft Products, a manufacturer of aircraft landing gear, makes 1,100 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 $71 and fixed costs of $65. The valves could be purchased from an outside supplier at $78 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:

Increase by $35,200.

Increase by $20,900.

Decrease by $20,900.

Decrease by $35,200.

Aircraft Products, a manufacturer of aircraft landing gear, makes 1,100 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 $71 and fixed costs of $65. The valves could be purchased from an outside supplier at $78 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

Scenario 1 for inhouse Production

To produce 1,100 units, variable costs are ( 1,100 x $71 ) = $78100
To produce 1,100 units, fixed costs are ( 1,100 x $65 ) = $71500

Total cost in this scenario = ( $78100 + $71500) = $149600

Scenario 2 (Buy from outside vendor):

Purchase cost of 1,100 units = ( 1,100 x $78 ) = $85800

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 ( $71500 x 0.60 ) = $42900

Total costs (outside vendor scenario) = ( $85800 + $42900 ) = $ 128700

Difference between inside scenario total costs and Outside scenario total costs are

Inside scenario total cost = $149600

Less; Outside Scenario total cost = 128700

Balance = 20900

So, by choosing the 'outside vendor' option, operating income would increase by $20900

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