Question

The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $185 with a resulting contribution margin of $73. Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $41,000 a year to inspect the CD players. An average of 1,800 units turn out to be defective - 1,260 of them are detected in the inspection process and are repaired for $80. If a defective CD player is not identified in the inspection process, the customer who receives it is given a full refund of the purchase price. The proposed quality control system involves the purchase of an x-ray machine for $190,000. The machine would last for four years and would have salvage value at that time of $21,000. Brisbane would also spend $590,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $22,000. This new control system would reduce the number of defective units to 370 per year. 300 of these defective units would be detected and repaired at a cost of $50 per unit. Customers who still received defective players would be given a refund equal to 150% of the purchase price.

Questions 1 & 2 [0 points; unlimited tries]

1. What is the Year 3 cash flow if Brisbane keeps using its current system?

2. What is the Year 3 cash flow if Brisbane replaces its current system?

Questions 3 & 4 [5 points each; 5 tries each] [NOTE: When computing present values, use the present value factors from the tables on page 118 in the Coursepack]

3. Assuming a discount rate of 6%, what is the net present value if Brisbane keeps using its current system?

4. Assuming a discount rate of 6%, what is the net present value if Brisbane replaces its current system?

Answer 1

(a) Year -3 Cash Flow using Current System
	Units	Rate	Value($)	Period	Discounting Factor	Present value($)
Inspection cost			$41,000	3	0.8396	$34,424
no of deffectives	1800
Detected	1260	80	$1,00,800	3	0.8396	$84,632
Undetected	540	185	$99,900	3	0.8396	$83,876
Net cash Flow in Year -3						$2,02,931
(b) Year -3 Cash Flow using Proposed System
	Units	Rate	Value($)	Period	Discounting Factor	Present value($)
Inspection cost			$63,000	3	0.8396	$52,895
no of deffectives	370
Detected	300	50	$15,000	3	0.8396	$12,594
Undetected(Refund value 125% 0f present sale price)	70	277.5	$19,425	3	0.8396	$16,309
Net cash Flow in Year -3						$81,798

(c)Present system
	Units	Rate	Value($)	Period	Discounting Factor	Present value($)
Inspection cost			$41,000	1 to 5	4.2124	$1,72,708
no of deffectives	1800
Detected	1260	80	$1,00,800	1 to 5	4.2124	$4,24,610
Undetected	540	185	$99,900	1 to 5	4.2124	$4,20,819
Net present value of Inspection /defective cost						$10,18,137

(d)Proposed system
	Units	Rate	Value($)	Period	Discounting Factor	Present value($)
Initial investment			$1,90,000	0	1	$1,90,000
Worker training			$5,90,000	0	1	$5,90,000
Inspection cost			$63,000	1 to 5	4.2124	$2,65,381
Salvage Value			-$21,000	5	0.7473	-$15,693
no of deffectives	370
Detected	300	50	$15,000	1 to 5	4.2124	$63,186
Undetected(Refund value 150% 0f present sale price)	70	277.5	$19,425	1 to 5	4.2124	$81,826
Net present value of Inspection /defective cost						$11,74,700