Question

Cysco Corp has a budget of $1,200,000 in 2015 for prevention costs. If it decides to automate a portion of its prevention activities, it will save $100,000 in variable costs. The new method will require $50,000 in training costs and $140,000 in annual equipment costs. Management is willing to adjust the budget for an amount up to the cost of the new equipment. The budgeted production level is 200,000 units.

Appraisal costs for the year are budgeted at $500,000. The new prevention procedures will save appraisal costs of $50,000. Internal failure costs average $30 per failed unit of finished goods. The internal failure rate is expected to be 5% of all completed items. The proposed changes will cut the internal failure rate by one-half. Internal failure units are destroyed. External failure costs average $50 per failed unit. The company's average external failures average 2.5% of units sold. The new proposal will reduce this rate to 1%. Assume all units produced are sold and there are no ending inventories.
What is the net change in the budget of prevention costs if the procedures are automated in 2015? Will management agree with the changes?

       A) $100,000 decrease, yes
       B) $90,000 decrease, yes

       C) $100,000 increase, no

       D) $90,000 increase, yes

Answer 1

Mgmt will accept the approval.

Total cost is of $1.2m. But company would save around $137k p.a. All the working are given below. Further there will be saving of $100k in variable cost which is more beneficial as there will be saving of $0.5 on every extra unit of produced/

Please note regarding Ext and Int Failure of Units. - The % for ext is based on units sold hence reverse calculation is carried out to facilitate the workings.