The Brisbane Manufacturing Company produces a single model of a CD player. Each

Question

The Brisbane Manufacturing Company produces a single model of a CD player. Each player is sold for $203 with a resulting contribution margin of $74.

Brisbane's management is considering a change in its quality control system. Currently, Brisbane spends $42,000 a year to inspect the CD players. An average of 1,800 units turn out to be defective - 1,440 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 $200,000. The machine would last for five years and would have salvage value at that time of $20,000. Brisbane would also spend $640,000 immediately to train workers to better detect and repair defective units. Annual inspection costs would increase by $20,000. This new control system would reduce the number of defective units to 380 per year. 310 of these defective units would be detected and repaired at a cost of $42 per unit. Customers who still received defective players would be given a refund equal to one-and-a-fourth times the purchase price.

a. Assuming a discount rate of 8%, what is the net present value if Brisbane keeps using its current system?

b. Assuming a discount rate of 8%, what is the net present value if Brisbane replaces its current system?

Explanation / Answer

Total cost due to defective and inspaction Present system Units Rate Value($) Period Discounting Factor Present value($) Inspection cost 42000 1 to 5 3.9927 167693.4 no of deffectives 1800 Detected 1440 80 115200 1 to 5 3.9927 459959.04 Undetected(Refund value 125% 0f present sale price) 360 203 73080 1 to 5 3.9927 291786.52 Net present value of Inspection /defective cost             919,438.96 Proposed system Units Rate Value($) Period Discounting Factor Present value($) Initial investment 200000 0 1 200000 Worker training 640000 0 1 640000 Inspection cost 62000 1 to 5 3.9927 247547.4 Salvage Value -20000 5 0.6806 -13612 no of deffectives 380 Detected 310 42 13020 1 to 5 3.9927 51984.95 Undetected(Refund value 125% 0f present sale price) 70 253.75 17762.5 1 to 5 3.9927 70920.33 Net present value of Inspection /defective cost          1,196,840.69 If we we opt proposed syestem we inccured loss of $    277,401.73 (1196840.69-919438.96) Period Disc.Fact. 1 0.9259 2 0.8573 3 0.7938 4 0.7350 5 0.6806 Total 3.9927

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