Question

Flyer Ltd (Flyer) is an automobile manufacturer specialized in high-end motorbikes. The company manufactures and sells 10,000 motorbikes each year. Flyer’s management has decided to spend $1 billion in 2020 for a quality management program to improve the quality of the company’s products.

As a quality improvement initiative, the production manager suggests to replace the engine model that are currently used in all Flyer’s products. The new engine model will cost $250 per unit more than the existing one. However, he expects that the new model will bring to the company the following improvements:

1. reduction of 15,000 rework hours;

2. saving of 900 hours of customer support;

3. move 300 fewer loads;

4. reduction of 15,000 hours of warranty repairs;

He anticipates that, with the improved product quality, Flyer can sell an additional 100 motorbikes in the year, leading to additional contribution margin of $3,000,000.

To support his proposal, the production manager listed out the following data regarding the costs of rework and repair for Flyer’s products:

	Variable cost	Fixed cost	Total cost
	$	$	$
Rework cost per hour	80	115	195
Repair costs
Customer support cost per hour	40	65	105
Transportation cost per load	700	230	930
Warranty repair cost per hour	90	152	242

It is believed that even if the change can improve quality, it will not be able to save any of the fixed costs of re-work or repair.

Required:

(a) Should Flyer change to the new engine model? Show your calculations.

(b) Suppose the estimate of 100 additional motorbikes sold is uncertain. What is the minimum number of additional motorbike that Flyer needs to sell to justify adopting the production manager’s proposal?

(c) What other factors should Flyer’s management consider when making their decision about changing to a new component??

(d) Identify the four categories of cost of quality. Out of these four categories, what cost(s) should Flyer consider spending more on for its quality management programme? Explain briefly.

Answer 1

a)
Expected improvements
Particulars	Amount	working
Reduction of rework hours	$                              12,00,000	15000*80
Saving hours of customer support	$                                    36,000	900*40
Move fewer Loads	$                                 2,10,000	300*700
Reduction of warranty repair hours	$                              13,50,000	15000*90
Contribution on additional sales	$                              30,00,000
Total costs saved	$                              57,96,000
Additional variable cost per unit	$                                         250
*Volume	10,000
Additional variable cost spent	$                              25,00,000
Net costs saved	$                              32,96,000
Yes, Flyer should change to the new engine model
As it will save company net $ 32,96,000
b)
Particulars	Amount
Contribution on additional sales	$                              30,00,000
additional sales (units)	100
Contribution on per unit	$                                    30,000
Additional variable cost spent	$                              25,00,000
Total costs saved	$                              57,96,000
Less: Contribution on additional sales	$                             -30,00,000
Cost saved other than contribution	$                              27,96,000
If at all zero additional sales are done
Then too company saves $ 296,000
Minimumnumber of additional sales to justify production manager proposal is
ZERO
c)
Some of other factors to be considerd are:
Perfomance of new engine
Will it negatively affect the product or company's image
Availability of new engine
If new engine causes any malfunction company can repair it
d)
4 categories of cost of quality
Prevention Cost
Appraisal Cost
Internal Failure Cost
External Failure Cost
Type of costs	Category of cost
Rework costs	Internal Failure Cost
Customer support	External Failure Cost
Transportation costs	N/a
Warranty repair cost	External Failure Cost
Flyer should consider to spend more on
Prevention costs
Appraisal costs
As these costs will help company to identify defects and so reducing internal faliure costs and external faliure costs
As external faliure costs not only cost money but also company loses customers due to it

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